Tax planning isn’t a once-a-year-activity. In fact, thoughtful planning year-round can help you reduce your tax liabilities come April.
David Scaife, a wealth planner at U.S. Bank, says being proactive can help you maximize your benefits and minimize any surprises. Here, Scaife outlines six ways to plan for tax season throughout the year — so you’ll be in good shape when you file.
1. Do an income tax projection to prevent surprises at tax time
One of the most important steps to take is figuring out where your taxes stand before it’s too late to make changes. “The best thing to do prior to year-end is an income tax projection,” Scaife says. “Through the projection process, potential surprises might show up.”
Having a picture of your finances ahead of time gives you more breathing room. It can help you plan more effectively for the upcoming tax season and find ways to reduce your tax burden. Ask your wealth management professional to perform the projection and go over the results with you.
2. Find ways to reduce income tax
One of the easiest ways to reduce your income tax liability is to reduce your taxable income. You can defer your tax liability — or eliminate it entirely — when you make qualifying contributions to specific financial vehicles, such as:
- Retirement accounts and plans: You can make tax-deductible contributions to a 401(k) plan, 403(b) plan or traditional IRA.
- HSAs: Health savings accounts (HSAs) give you the triple tax benefit of tax-deductible contributions, tax-free earnings and tax-free withdrawals for qualified medical expenses.
- FSAs and DCFSAs: Flexible spending accounts (FSA) and Dependent Care FSAs (DCFSA) let you bypass taxes to save for healthcare costs and dependent care, respectively.
- 529 plans: A 529 plan allows you to make contributions while enjoying tax-free earnings and withdrawals for approved educational expenses.
“The best thing to do prior to year-end is an income tax projection. Through that process, potential surprises might show up.”
3. Minimize capital gains tax on investments
A capital gain refers to selling something for more than you spent on it, such as stocks. The federal government charges you for this profit with what are called “capital gain taxes.” There are several techniques you can use to reduce your tax burden on your investments. Scaife suggests these five strategies:
- Spread your sale over two years. If it’s practical for you, sell only a portion of your appreciated assets this year and the remainder the following year.
- Transfer appreciated assets to a child. If your child is not a dependent and is in a lower tax bracket, they might see significantly less tax for the capital gains.
- Transfer appreciated assets to a charity. You’ll avoid the capital gains tax entirely and, in most cases, be able to claim a deduction for the fair market value of those assets.
- Take advantage of tax loss harvesting. Defer taxes by using your market losses to offset some of the gains your assets see over the course of the year.
- Invest your gains in Opportunity Zone funds. By shifting your money to qualified funds for disadvantaged communities, you get to defer and even reduce the tax you owe.
4. Take advantage of new rules around the estate tax and gift taxation
Make the most of the annual gift tax exclusion, which is the amount of money you can gift to an individual per year, tax free. “You can transfer $15,000 to an individual each year without any gift tax implication,” Scaife explains, “and you don’t have to be related.”
A couple can also collectively gift up to $30,000 to an individual each year, and you’re free to make gifts year after year to multiple people. “It can add up quickly,” Scaife says, “and there would be no estate tax or gift tax implications to those transfers.”
Additionally, the Tax Cuts and Jobs Act (TCJA) more than doubled the gift tax lifetime exemption, which is the total amount of money you’re allowed to gift over your lifetime, tax-free. In 2020, it’s $11.58 million per individual and $23.16 million for a couple.
5. Re-examine your charitable giving
The TCJA raised the standard deduction to $24,800 (in 2020) for married couples and to $12,400 for single filers. This increase has meant that fewer people may be itemizing deductions.
However, most people don’t donate to charity for the tax deduction – they do it because they’re passionate about a specific cause or organization. So, to make the most of your donations and increase your tax savings, Scaife advises using a “bunching” strategy. With bunching, you replace several years of smaller donations with a large donation in a single tax year. This allows you to benefit from itemizing your deductions and claiming the tax benefit of your contribution.
Scaife notes that some people use donor-advised funds for their giving. You can make a single, “bunched” donation while instructing the fund to spread your contribution to a charity of your choice over a period of several years. “But remember,” Scaife says, “you only get the deduction when you contribute. You don't get the deduction when those contributions are made by the fund.”
If you’re taking required minimum distributions on retirement funds, you have an additional option available to you in the form of qualified charitable contributions. Instead of taking those distributions as cash, funnel some or all of that distribution directly to a charitable organization. Scaife notes that you’ll get to enjoy both the high standard deduction under TCJA and have your donated distribution taken directly off the top of your taxable income.
6. Work closely with a wealth management professional
A wealth management professional can help you see how different aspects of your finances — taxes, investments, etc. — can work together to help you achieve your goals. “As wealth planners, we have the full picture,” Scaife says. “We know where our clients want to go with their money, because we've had these discussions.”
Share your vision and take full advantage of their expertise. Scaife recommends working with professionals who understand your entire estate and consider your goals when devising portfolio management and tax strategies for you. With a little planning, you can be more strategic about your taxes year-round.
Mutual fund investing involves risk and principal loss is possible. Investing in certain funds involves special risks, such as those related to investments in small- and mid-capitalization stocks, foreign, debt and high-yield securities and funds that focus their investments in a particular industry. Please refer to the fund prospectus for additional details pertaining to these risks.