Tax Planning & Strategy

December 19 2014

Currently, our company sign on Hamilton Boulevard reads “Plan your 2014 taxes now”. The truth is, taxes aren’t going anywhere but up so the best thing you can do is learn your options and make a plan.

The very first question is “what was my effective tax rate last year and will it be the same for this year”?  All of us should know what our marginal tax brackets are, but understanding our effective tax rates and how to control them (to the extent it’s possible) can help in a host of ways.  “Effective tax rate” and “average tax rate” are generally equivalent concepts.  They both represent the percentage of your total income you actually pay in taxes.   Many folks have the misconception that since they are in the 25% bracket that they pay 25% of their income in federal income tax every year.   For example you might be in the 25% marginal tax bracket but due to the structure of your investments and your business, the actual total tax may be anywhere from 12% to 40%, allowing for tax-free income, capital gains & losses, dividends and self-employment tax.

The next set of questions revolves around “Where are we this year?” and “What are our goals?”  As tax & business planners, those answers tell us whether this is the year you can realize additional income without adding to your tax burden, or alternatively it might be smart to buy that business machine and install it now instead of next year to reduce income.   Perhaps your investment advisor can increase or decrease loss harvesting in your portfolio.  ROTH conversions and early IRA distributions become potential choices, depending on whether it’s smart to increase or decrease income.  For our business clients, we strongly discourage spending company dollars simply to avoid tax.  OF course we all want to pay the lowest possible amount of tax but there is no sense in waking up on Jan 1st with a few cobwebs from the previous night’s celebration and a depreciation hangover for unnecessary equipment that could have gone into developing a more useful competitive advantage.

In individual planning, goals remain an important focus.  If you have IRAs, 401(k)s or other deferred plans and need to have more tax paid in to avoid a penalty, a distribution that goes entirely to the tax man might save money in the long run.  For individuals whose retirement plans include such things, increasing contributions before year end could net you additional savings in 2014; ditto for business owners, particularly those with a profit sharing plan or a profit-sharing amendment to a 401(k) in place.

There are a lot of moving parts in any good tax plan, but understanding your effective tax rate and knowing both your current situation and your personal financial goals, there are many options to choose among, but wise choices depend on all of your team (tax professional, investment advisor, and business decision makers) understanding your circumstances and acting effectively before the end of the year.

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