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updated: July 16, 2024There’s more to tax planning than keeping track of your important tax documents—although that is a great start. Proper tax planning utilizes the current tax law to maximize your tax deductions and credits and minimize your tax liability.
Used effectively, it can be an important part of your financial management strategy and help you meet your short- and long-term financial goals. Tax planning—as a component of comprehensive financial planning—is important for both individuals and businesses.
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Deducting, deferring, dividing, disguising, and dodging are key components. These are also known as the five pillars of tax planning. By implementing these tax-saving strategies, you can minimize your tax liability and preserve more of your income for your financial goals.
You should be taking full advantage of all deductions and credits available to you. As an individual taxpayer, maximizing your deductions may mean either taking the standard deduction or itemizing your deductions. You should also be aware of tax credits that may be available to you based on your lifestyle and spending habits. Tax laws change frequently, and you may be eligible to claim tax credits for expenses you have incurred—such as education or energy savings.
Timing your income and expenses appropriately is a key component of tax planning. As a rule of thumb, you want to delay paying tax until the last possible moment. Due to the time value of money, an expense in the future is cheaper than an expense right now. Similarly, income now is more valuable than income in the future.
You may be able to legally shift money to other family members who pay taxes in a lower tax bracket. This tax-planning strategy is referred to as income splitting.
Disguising involves converting money from one type of income to another that is taxed at a lower rate. For example, for every new dollar of income you bring in, ordinary income is taxed at your marginal tax rate while most capital gains are taxed at a maximum of 20% in 2023.
This does not refer to tax evasion: the illegal hiding of income which results in an underpayment of required taxes. Dodging refers to tax avoidance—arranging your finances to pay the lowest possible taxes while adhering to the current tax laws.
As an individual taxpayer, you should maximize your deductions and be aware of various tax credits you can take based on your lifestyle and expenses. As much as possible, make tax-efficient investments and set yourself up for a tax-friendly retirement. If you have the ability to transfer money to another family member in a lower tax bracket, you can also take advantage of income splitting.
It is important to understand the difference between standard and itemized deductions. Depending on your financial situation, you may benefit from itemizing your tax deductions.
The standard deduction is a specific amount that the Internal Revenue Service (IRS) allows you to deduct from your income before calculating your tax liability. The amount changes annually, and the IRS releases its inflation adjustments on its website prior to the relevant tax year.
For tax year 2023, the standard deduction is:
Itemized deductions are specific amounts you have paid for certain allowable expense categories throughout the tax year. If the sum of all your expenses exceeds the standard deduction for the tax year, you should itemize your deductions. The following expenses may be included in itemized deductions:
Read this article for seven common write-offs you can deduct from your taxes.
Unlike deductions, tax credits directly reduce the amount you owe on your tax bill. For example, a $2,000 tax credit will take your $10,000 tax liability down to $8,000. This makes tax credits even more valuable than tax deductions on a per-dollar basis. Some of the most significant tax credits relate to your children or other dependents and education expenses.
Here are some child-related tax credits you may qualify for:
Here are some education-related tax credits:
Other tax credits include those for low-income earners, retirement savings, and energy savings, such as:
A 529 plan, or qualified tuition program, is a tax-advantaged education savings account. While you cannot deduct contributions made to a 529 plan, the withdrawals are tax-free if used for qualified educational expenses. You also benefit from the tax-free growth of your invested funds.
There are several tax-advantaged retirement options to consider. Here are three of the most common.
A tax-advantaged investment is any investment option that offers a tax benefit. It could be tax-deferred (401(k) or traditional IRA), or tax-exempt in the future (Roth IRA). Including tax-advantaged accounts in your portfolio is a good tax planning strategy.
Robinhood offers traditional IRAs and Roth IRAs for individuals who are looking to save for retirement outside of their employer. You can easily fund your retirement account by setting up an automatic transfer to your Robinhood account. It’s a great option for investors who want to have control over their retirement account.
Moving to a state that is tax-friendly for retired individuals is a great retirement-planning strategy. For example, the following eight states do not tax retirement income:
Other states may have special provisions that limit the tax you will pay on your Social Security or pension income. Read this article for more information on states that don’t tax retirement income.
Here are a few common tax-planning strategies for your small business.
The QBI deduction allows owners of pass-through businesses to deduct up to 20% of their share of the business’s income. If you qualify, this is a great benefit for a small business owner.
Pass-through businesses are those where the owner pays taxes on their share of the business’s income on their personal tax return—such as a sole proprietorship or partnership. C corporations do not qualify for the QBI deduction.
As a small business owner, you likely use the cash method of accounting. With cash accounting, you recognize revenue when cash is received and expenses when cash is paid. This allows for some flexibility in how you time your revenue and expenses around year-end.
If you expect to be in a higher tax bracket next year, you can defer paying an expense until January to reduce your future net income. If you expect to be in a lower tax bracket next year, you may want to delay sending an invoice to your clients until January to keep your current year’s net income lower. Tax laws are constantly changing, and tax rates for pass-through business owners may change considerably in certain years. Your tax professional can help you identify these opportunities.
As we mentioned earlier, it’s always a good idea to defer paying taxes as long as possible. You may be able to defer capital gains tax by reinvesting the funds from your sale in another way. Here are two methods:
Eligible small businesses may qualify for a tax credit of up to $5,000 for the set-up expenses incurred in starting a SEP, SIMPLE IRA, or 401(k). Your business may qualify if you had the following:
Additionally, you can deduct your own contributions to your 401(k) after setting up the plan.
A tax-efficient investment strategy allows your investments to grow more quickly thanks to the extra funds retained from your tax savings. Of course, always diversify your investment portfolio to minimize your risk in the long term. But for the current tax year, you may be able to utilize loss harvesting to minimize your tax bill.
Diversifying your investment portfolio reduces your long-term risk due to market fluctuations and changing tax laws by allocating your funds across various investment types. For instance, you can hold some retirement funds in a tax-deferred account, where you will pay taxes in retirement, and some in a tax-exempt account, where you pay taxes now but not when you withdraw. Similarly, you may want to blend higher-risk investments with some low-risk, more stable investments. Yieldstreet offers an array of available investments - from real estate and art to diversified funds to both accredited and non-accredited investors with a potential for substantial returns. Learn more on our review.
