The two goals of tax planning

By Ryan Fair, CPA, CFP^®

The end of summer has officially arrived. And while no one wants to say goodbye to long days and relaxing getaways, the time has arrived to get back to school, back to work and, at least in my case, back to some serious tax planning.

For many taxpayers, however, the whole idea of tax planning remains a bit of a mystery. But while it may be true that the two things in life that are certain are death and taxes, what’s also true is that careful tax planning can make the second piece of that equation a little less daunting.

Unlike tax preparation, which is simply the process of filling out the IRS forms, tax planning involves coordinating your financial strategy with the current tax code. The two primary goals of tax planning are 1) to avoid surprises at tax time, and 2) to identify opportunities to minimize taxes over your lifetime.

Goal 1: Avoid tax surprises

It’s safe to say that no one wants the surprise of a higher-than-expected tax bill when April 15 rolls around. And while a higher-than-expected refund may come as a pleasant surprise, from a tax planning perspective, that also means that things could have been managed better throughout the year. Ensuring that you’re paying in the correct amount of taxes throughout the year not only keeps surprises at bay, but it also evens out your cash flow over each 12-month period.

Last year, avoiding tax surprises proved to be a challenge for a number of reasons. When the Tax Cuts and Jobs Act (TCJA) was first introduced, it was touted as the solution to simplifying the tax code. As we all know now, it did anything but. Even the IRS had difficulty figuring out the new, complicated rules, and when the 2018 withholding tables were created, they were flat out wrong. As a result, many people did not withhold the correct amount for the 2018 tax year. It was a mess, and yes, there were lots of surprises!

To avoid similar surprises in 2019, start by creating a mock tax return. Using your pay stubs and other withholding information, compare the percentage you’ve had withheld to date with last year’s numbers. Next, use the recently updated IRS Tax Withholding Estimator to do a quick ‘paycheck checkup’ and be sure you’re at least in the ballpark for withholdings. (Though you may not have much faith in an online IRS tool after last year’s debacle, in the few trials I’ve run myself, it does seem to be pretty accurate.) If you have under-withheld for the year, increasing your withholdings now can help reduce what you owe in April and eliminate underpayment penalties to the IRS. If you’ve withheld too much, you can reduce your withholdings for the remainder of the year, putting more cash in your pocket with every paycheck.

Goal 2: Identify opportunities

Once you know you’re on track with your withholdings, you can seek out other opportunities for tax savings. Your financial advisor or tax advisor can help you explore your options and identify strategies that may work best for you. Some things to consider include:

• Increasing pre-tax retirement plan contributions.  If you need to reduce your taxable income to ensure a lower tax bracket, you may choose to contribute the maximum amount to available pre-tax savings vehicles, such as a traditional IRA, a 401(k), or a Health Savings Account (HSA). You can read more about the powerful tax benefits of HSA accounts here.
   
• Contributing to an Indiana 529 Plan.  If you are an Indiana resident, you can reduce your state taxes while saving for current or future education expenses by contributing to Indiana’s College Choice 529 Plan. Indiana allows a credit of 20% of your plan contributions—up to $1,000—on your 2019 Indiana income tax return. Plus, all 529 Plans grow free of federal and state income taxes. You can read more about Indiana’s 529 Plans here.
   
• Contributing to a Roth IRA.  If your projected taxable income is in a lower tax bracket and you don’t need to reduce your income for the year, now may be a good time to contribute to a Roth IRA. Because a Roth IRA is funded with after-tax income now but is not taxable when withdrawn, you can increase your non-taxable income in retirement.
   
• Completing a Roth Conversion.  Because we are currently in an era of historically low tax rates, your advisor may recommend paying taxes on some of your retirement savings today and allowing that money to grow tax-free. Since tax rates are likely to be higher in the future, your savings could be significant. Learn more about Roth IRA Conversions here.
   
• Maximizing your charitable donations.  The new tax law’s higher standard deduction has made it more challenging to receive tax benefits from charitable donations—but it is still possible with smart planning. ‘Bunching’ two years of gifts into a single tax year may be enough to push you above the standard deduction. Establishing a Donor Advised Fund allows you to make a lump-sum donation to take advantage of the up-front charitable tax deduction in the current year. If you are over 70½, a Qualified Charitable Distribution is an option that allows you to use pre-tax money in your IRA to make your charitable contributions, potentially doubling your tax savings. Learn more in my blog post here.

As you can imagine, this is just the tip of the iceberg. The tax law is complex (despite futile attempts to make it less so!), so your best bet is to work with an advisor who understands both the nuances of the law and your own financial situation. Even small events can have a big impact. A child’s 17^th birthday will reduce your child tax credit from $2,000 down to $500. A child graduating from college may take away your education and child tax credits, potentially boosting your taxes by a whopping $2,500. If you own a small business, maximizing Qualified Business Income (QBI) deductions can save you a bundle. Remember that no matter what your financial situation may be, planning now for next tax season can help you avoid surprises, take advantage of tax-savings opportunities, and, most importantly, give you peace of mind knowing that your taxes are in order long before tax day on April 15.

For more smart tax planning strategies from Ryan Fair, subscribe now to our Wise Money Show podcast here and be sure to tune in on Saturday, August 24!