What Is Proactive Tax Planning, and How Can It Help Your Financial Plan?

Most taxpayers think of their taxes once a year when they file. They assume that gathering all of the information their financial professional, or accountant, needs is the extent of the “planning” they need to do. After all, once the “accounting” is complete, taxpayers will either receive a refund or make a payment to the government if they owe money. Isn’t it just that cut and dry?

In a word: no. 

Truly proactive tax planning is so much more than just the tax preparation done by your accountant during filing season. At Wood Smith advisors, our goal is to help our clients with proactive tax planning to help them better manage their taxes with current tax laws. Let’s walk through what, exactly, proactive tax planning entails and how it can positively impact your finances.

What is Proactive Tax Planning?

Planning ahead to ensure a tax-efficient financial strategy starts early in the year and carries on from January to December. Early in the year, your tax planner’s job is to look at tax laws, any impending changes, and to review your recently prepared tax return as well as any forecasted tax activity for the year. A second review in the fourth quarter will enable taxpayers to make final adjustments. When your financial strategy considers current tax law, you’re able to create uniquely timed financial decisions that minimize your tax liability and avoid penalties. In order to take advantage of many options, action must be taken by December 31.

What Financial Activities Can Be Planned Around Tax Laws?

There are a number of financial decisions and activities that can be planned around tax law to impact your taxable income. Several decisions that could be impacted by your unique tax position and current tax laws are:

1. When to sell your home.
2. How much to deposit into tax-advantaged retirement savings accounts through payroll withholdings, including Roth options.
3. Whether or not you should convert money from a Traditional IRA to a Roth IRA, or whether you should consider a Backdoor Roth IRA. 
4. Using tax-advantaged benefits such as Health Savings Accounts or Flexible Spending Accounts.
5. How much you should pay throughout the year in estimated tax payments to avoid a penalty next filing season.
6. Whether or not you can or should donate part of your RMD to charity. Timing is important to obtain proper tax treatment.
7. Whether using a Donor Advised Fund for charitable contributions can help you manage your taxable income.
8. When (or if) you should buy or sell investments in your portfolio.
9. How to leverage your investments to offset gains or losses to minimize your liability using Tax Loss or Tax Gain Harvesting. 
10. How to manage stock options, restricted stock units, or deferred income.
11. How to purchase or manage your rental property.
12. Ways to navigate your business finances, and how to choose (or fund) tax-advantaged employee benefits for yourself and your team.
13. How to appropriately gift money to loved ones both now and as part of your estate plan. 

Adjusting Your Tax Withholdings Throughout the Year

Unfortunately, many taxpayers view their annual tax refund as a kind of annual bonus. They count on those funds to fund financial goals, or to help offset the costs of major purchases. While it can be nice to receive a lump sum of cash once a year, it is often more beneficial for investors to have that money in the form of income throughout the year. This can be accomplished by adjusting your withholdings based on this year’s return. 

The truth is, when you get a large tax refund each year, the government is “holding” that overpayment for you. You aren’t earning interest on that money as you would be at a bank or in your investment portfolio, and it could be used toward your financial goals in an ongoing capacity. 

In fact, even if it feels uncomfortable at first, your goal should be to owe a small amount of money each year when you file. This ensures that you have all of the money you’ve earned for you toward your unique goals all year long. Beware that owing too much money may result in penalties for underpayment.

Working with a tax professional and a financial planner can help you to ensure that you’re withholding the right amount so that you don’t owe too much. If you do receive a small refund when you file, it can be prudent to apply those funds to next year’s tax liability. This can allow you to reduce your withholding throughout the year, and avoid owing a significant amount in the future.

There’s Never a Bad Time To Start Proactive Tax Planning

Although many tax professionals and financial planners start the tax planning process at the beginning of the year, it’s never too late to begin. Reach out to a financial advisor or tax professional to start proactive tax planning today. 

Have questions?

We’re happy to help. As a member of AICPA, our firm focuses on holistic financial planning with a proactive approach to tax strategy. Reach out to us today by clicking here.

Wood Smith Advisors, a woman-owned Registered Investment Advisor (RIA), is a fee-only financial services firm that partners with its clients to simplify their financial lives. We focus on women, entrepreneurs, and individuals with complex financial situations, providing objective and competent advice, education and services to help them develop and build their businesses and reach their financial goals. We can be reached by clicking here.

"Finance Made Simple" blog posts are intended for educational purposes and not for specific advice. Each person’s situation is different. Consult your financial advisor for advice relating to topics discussed.