Planning is Everything When it Comes to Taxes

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On Personal Finance

Planning is Everything When It Comes to Taxes
Rande Spiegelman
CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research
January 31, 2003

Most of us think about taxes maybe twice a year, at the end of the year and just before April 15. But that’s not the best approach toward an important part of investing and financial planning. We outlined the benefits of early tax planning in "Get Started on Your 2004 Taxes". If early planning can yield significant savings, then year-round planning should be even better, right? Right.

As you prepare for last year’s return, start thinking about this year’s situation. Once the prior-year return is completed you can run a pro-forma return for the current year. Use last year’s return as a base and make the appropriate changes according to your best estimate of what might be different this year. This sort of power planning might help you save money in all sorts of important ways:

Armed with a projection of your current-year situation, you can double-check your withholding to make sure you’re not paying too much or too little. The same applies if you make quarterly estimated tax payments.
Based on your projections, you might feel more comfortable making your current-year IRA contribution and/or contributing to an Education Savings Account earlier rather than later.
Knowing your projected marginal income tax bracket will help you make tax-smart investment decisions, such as whether municipal or taxable bonds make sense in taxable accounts, which assets go best in taxable vs. tax-advantaged accounts, or how much bang for the buck you might receive from harvesting capital losses.
Does it make sense to defer income and accelerate deductions this year? Are you subject to the federal alternative minimum tax (AMT)? How much tax will you save from making charitable contributions? Running a projection of your current-year estimated income tax liability could help you answer such questions and potentially give you a big advantage in planning to maximize after-tax cash flows for the year ahead.

Tax planning, as with all personal financial planning, should be ongoing and not a one-time event. Personal circumstances can (and frequently do) change throughout the year. Some of the more obvious changes to your personal circumstances might involve marriage, divorce, a new baby, capital gain transactions, changes in employee compensation or sale of a home. However, there are other changes which you might not be considering that can affect your taxes.

Refinancing a mortgage, exercising stock options, or children who can no longer be claimed as dependents will impact your tax situation. Furthermore, it seems our representatives in Washington, D.C. and the state capitals are always tinkering with the rules and regulations in one way or another. If we waited until everything was settled, we’d never get started!

Once you have a plan in place, you’ll be better equipped to deal with and even take advantage of any changes that might come your way. With a base plan established, it’s a relatively easy matter to change a few numbers here or there in a “what if” exercise when contemplating important transactions before the fact, such as a sale or purchase of a home, refinancing a mortgage, securities sales, exercising stock options, making charitable gifts and so on.

Remember this: It’s not what you make, it’s what you keep that counts. The goods and services we buy are purchased with after-tax dollars. The year-round approach to tax planning can help you increase your after-tax cash flows, help you make better financial and investment decisions, and it can mean less surprises and more savings come tax time.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, or legal, tax, or investment advice, or a legal opinion. Individuals should contact their own professional tax and investment advisors or other professionals to help answer questions about specific situations or needs prior to taking any action based upon this information.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation. Data contained here are obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed.

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