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.
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.
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:
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.
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.
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.