The Importance Of Tax Planning

The Importance Of Tax Planning

financial plannerWe hear the term "tax planning" pretty frequently, but what does it mean, exactly?
What tax planning is all about.
While the term "tax planning" is frequently used, it is seldom defined. Tax planning is the process of arranging your financial affairs in ways that permit you to postpone, or even avoid, the payment of taxes. Doing so gives you more money to spend, save, and invest. You can lessen your tax burden by accelerating tax deductions and credits, and taking advantage of other tax law provisions. Of course, you shouldn’t change your financial behavior just to avoid taxes, but effective tax planning allows you to reach your goals while also reducing your tax bills. The key is to consider the tax impact of your transactions in advance, to avoid making impulsive moves. Seeking professional advice prior to entering into significant transactions is typically money well-spent.
What is the relationship between tax planning and financial planning?
The process of tax planning is an important component of effective financial planning. Many people are paying more in taxes than they need to, without realizing just how much of their wealth is being stripped away from them. Every dollar lost to taxes is another dollar that can never be invested in your future. When you reduce your tax burden and invest that money, you build toward your future. Don’t ignore the impact of taxes, and don’t wait until the end of the year to think about them. Smart planning along the way will allow you to find ways to reduce your tax burden - and invest those tax savings in your future.
Financial planning is the process of devising strategies to help you reach your local financial planning san jose goals, whether they are short or long-term. Tax planning impacts financial planning, since taxes are so high. If you have a sizable income, taxes will likely be your biggest single long-term expense! Taxation is an opportunity cost, since paying $100 in taxes means you no longer have that same $100 available to save, spend, or invest.
Why you need to make the connection between financial planning and taxes.
Far too many people fail to understand the importance of tax planning until they make a serious mistake that results in a sizable tax burden. For instance, Julie is 40 years old and single. She considers herself to be knowledgeable when it comes to financial matters, but she is not well-versed on taxes. Julie meets Jerry, and they decide to marry. Julie plans to move into Jerry’s home, so she decides to sell her house. She is thrilled to discover that it has appreciated by $500,000 since purchasing it 17 years ago. Unfortunately, by selling her home without considering the financial impact of taxation, Julie lost $62,500 to taxes ($250,000 gain taxed at an assumed combined federal and state rate of 25%).
Without any tax planning, Julie will have a $250,000 gain on the sale of her home for federal income tax purposes. (Profit of $500,000 less the $250,000 home sale gain exclusion applicable to single filers.) On the other hand, planning ahead can yield a very different result. Julie could choose to keep her home and live there with her new husband Jerry for two years, prior to putting the house up for sale. This would allow her to take advantage of the larger $500,000 home sale gain exclusion available to married joint filers, thereby avoiding the $250,000 in taxable gains. Of course, Jerry’s home could be sold instead of Julie’s. Or, Jerry could have kept his home and remodeled it while living in Julie’s home for the required two years.
The final word.
There are numerous other tax planning mistakes that can really cost you:
● Selling appreciated securities shortly after purchasing them can result in higher short-term capital gains taxes, when those same investments could have been taxed at much lower long-term rates.
● Withdrawing funds from a retirement account before you’ve reached age 59 ½ subjects you to a 10% premature withdrawal penalty.
● Individuals with a modified adjusted gross income in excess of $114,000 ($166,000 for married couples filing jointly) aren’t allowed to contribute to a Roth IRA. Doing so subjects you to a 6% penalty on your contribution.
● Missing your quarterly estimated tax payments will result in an estimated tax underpayment penalty of around 8% per year for each quarter that the taxes remain unpaid.
● When reinvesting dividends into a mutual fund, be sure to add the cost of the newly purchased shares to your tax basis when calculating your taxable gain from a sale. Otherwise, you will overpay the IRS.

If you find that you’re losing too much of your income to taxes, the solution is to plan your financial moves in advance with taxes in mind, rather than making impulsive decisions. Furthermore, hiring a professional tax advisor to guide you through complex transactions is generally a good idea.