Tax Planning

Tax Efficient Planning

One of the most impactful pieces of financial planning knowledge you can get today is to determine your overall future tax liabilities and proactively implement sound strategies to help minimize your tax exposure.

Today, we benefit from a high estate tax exemption amount while Federal income tax rates are the lowest they have been in over 40 years. Pre-Regan, the highest US Federal Income Tax rates were near 70%. 

Knowing whether or not the US Government will continue to raise Federal income tax rates and lower the estate tax exemption amount to put a damper on the huge $128 Billion dollar Federal Deficit* is unknown. 

 However you feel about the tax man, complaining is going to get you nowhere. This has nothing to do with fairness or justice. It’s about planning. The following are five tax efficient planning areas you should review with your financial advisor, tax professional and attorney.

4 Tax Smart Planning Strategies

(1) Saving: The first step towards tax-efficient investing and planning is to first determine how your financial accounts are structured under the law. Generally speaking, accounts can be classified in three “buckets” as taxable, tax deferred or tax exempt. 

Consider the rule of thumb to save 15% or more of your household gross income for your retirement. Utilizing all three buckets as part of your savings strategy can provide greater liquidity and tax flexibility before and after you retire.  Consider to use the 50/25/25 strategy.

Save 50% of your income earmarked for retirement in a before-tax “tax deferred” retirement account such as your employer 401(K) or 403(B) as a starting point. If you are self employed consider saving to your own 401(k) or IRA-based account (such as a SEP or SIMPLE IRA.)

Next save 25% into an after tax “tax deferred” account (such as a Roth IRA if you qualify.) This strategy can provide you greater cash-liquidity in case of emergency or unemployment before retirement, and a more tax-preferable approach to income distributions in retirement. 

Finally, consider to save the final 25% in after-tax “tax exempt” investments such as municipal bonds along with a diversified portfolio of investments allocated according to your risk tolerance, time frame and investment goals.

(2) Harvesting: Tax harvesting is an important tool that involves selling investments at a loss to offset a capital gains tax liability. Tax harvesting is typically used to limit the recognition of short-term capital gains, which are normally taxed at higher federal income tax rates than long-term capital gains. Keep in mind, short-term gains (on assets held for one year or less) are taxed at your ordinary income rate, which can range from 10% to 39.6%. 

Make sure to review your short term and long term capital gain and loss opportunities each year. Don’t hold onto your “dog’s of the Dow” because you are concerned about the tax “bite” or are waiting for a miraculous rebound of an investment.

Remember that “net capital losses” (total capital losses minus total capital gains) can be deducted up to a maximum of $3,000 in a given tax year against your ordinary income. The net amount of capital losses that aren’t deductible for the current tax year can then be carried over into future tax years during your lifetime.

(3) WithholdingNext, do your homework to make sure you do not greatly overfunding your income taxes to Uncle Sam just to get a big fat refund check back every spring. You are better off utilizing this money to pay down debt or earmarking this money for retirement savings.

Most people pay the bulk of their annual Federal Income tax bill via payroll withholding. Through this process, a percentage of your pay is taken out each pay period and sent to Uncle Sam. Consider that you are required to pay either 90% of this year’s tax liability or 100% (or 110%) of last year’s tax liability depending on whether you earned under or over $150K.

Many circumstances can affect the amount of tax you’ll eventually owe including marriage, divorce, having a baby, a job change or loss which can affect your taxable income for the year. Consider to review your total employer paystub “W-4” withholdings from the prior year every January. 

If you calculate that you are greatly overpaying your Federal Income Taxes, you should increase the number of personal allowances on your W-4 Tax form.  If you have too little taken out, you should decrease the number of personal allowances as you may owe money big-time when you file your return.

(4) Estate Planning: Tax planning can have a significant effect on the amount of wealth you will be able to transfer to your heirs if your taxable gross estate falls above the national estate tax exemption amount of $5.43M per person this year. Married couples can get the benefit of two individual exemptions, so in 2015 the total exemption per couple will be nearly $11 million.

Some states still currently have an exclusion amount that is significantly lower and will set precedence over the Federal amount. For example, New Jersey has a low $675K exemption amount.  A 40% tax rate will be applied to any excess over the exemption amount.

Work with your tax professional and financial advisor to help ensure your estate plan strategy takes full advantage of available tax credits and deductions as well as provide strategies that include advanced estate planning techniques, to help ensure you and your heirs are maximizing wealth for generations to come. 

Or, perhaps just moving from a low exemption amount state like NJ to a state on the Federal grid, like Florida, could not only save you and your heirs money, but perhaps add a few years to your life as well.

*Source: Forbes 9.16.14 “The Federal Budget Deficit”

Note: This information on Federal income taxes is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.

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