What Makes Tax Planning Important
Taxes are one of life’s certainties, and no one likes giving up some of their hard-earned cash. With proper tax preparation, however, it’s possible to pay less in taxes or receive a larger refund at the end of the year. While paying taxes is inevitable, there are several ways to diminish your tax burden and end each year with more money. Proper tax planning makes it easier to build your personal finances and afford the things you want.
Additionally, by anticipating taxes when you create your financial plan, it’s possible to significantly boost how much money you will have in retirement. Many elements of tax planning are quite simple, but it’s always worth speaking with a professional at a local bank who can offer additional guidance on how to successfully work within the tax system.
A tool for retirement
Saving for retirement is difficult under any circumstances, and it can be even harder to set money aside after taxes. Luckily, many retirement savings options allow you to set money aside without paying taxes on that income. Once that money has been placed in a separate account, it can gain value based on interest or investments. You will not be charged taxes on that money until you remove it from the retirement account. By that time, it’s likely you’ll be in a lower tax bracket and need to pay significantly less.
While these accounts do not let you eschew taxes entirely, deferring payment allows you to maximize your savings and minimize the amount of taxes that eventually need to be paid. A range of other accounts offer similar provisions, including Health Savings Accounts that remove money from your paycheck before income taxes are taken out, and Dependent Care Savings Accounts.
Take a long-term approach
Tax planning offers short and long-term benefits, but you’ll want to take a long view of your financial situation to maximize savings. If you anticipate an increase or decline in your income during the next few years, start catering your financial plan to the upcoming shifts ahead of time, according to CNBC. Figure out if it’s best to pay taxes on that increased income right now, or if you should try and put it all into tax-deferred accounts that may incur taxes later on.
Consider every part of your financial life
Taxes affect so many parts of your life that you may forget different ways to save. If you fail to consider the tax implications of a big financial decision, you could end up wasting a lot of money. The tax laws surrounding home sales can be particularly painful for uninformed buyers and sellers, according to MarketWatch contributor Bill Bischoff. For example, people can get an exemption on capital gains taxes on a home sale if they file jointly with a spouse.
This can result in massive savings for couples, but far too many people fail to consider this factor when they list their home. By speaking with a financial professional before taking any financial action, you can prevent yourself from accidentally missing out on significant tax exemptions.
Go itemized or standard
Whenever you file your taxes, you have the option between taking the standard deduction given to all filers or creating a custom deduction by listing your expenses for the year. Either option can offer better savings, depending on your financial situation, so you’ll want to evaluate exactly how your financial life changed during the past 12 months. With proper tax planning, you can make your financial life much easier and pocket additional money along the way.
Here are key tax considerations for year-end planning for both businesses and individuals:
Business year-end tax-planning considerations:
- Accelerate AMT refunds.
When the Tax Cuts and Jobs Act (TCJA) repealed the corporate alternative minimum tax (AMT), it allowed corporations to claim all their unused AMT credits in the tax years beginning in 2018, 2019, 2020 and 2021. The Coronavirus Aid, Relief, and Economic Security (CARES) Act accelerates this timeline, allowing corporations to claim all remaining credits in either 2018 or 2019. This gives companies several different options to file for quick refunds. The fastest method for many companies will be filing a tentative refund claim on Form 1139, but corporations must file by Dec. 31, 2020 to claim an AMT credit this way.
- Use current losses for quick refunds.
The CARES Act resurrected a provision allowing businesses to use current losses against past income for immediate refunds. Net operating losses (NOLs) arising in tax years beginning in 2018, 2019 and 2020 can be carried back five years for refunds against prior taxes. These losses can even offset income at the higher tax rates in place before 2018. Consider opportunities to accelerate deductions into a loss year to benefit from this rate arbitrage and obtain a larger refund. Accounting method changes are among the most powerful ways to accelerate deductions, but remember any nonautomatic changes you want to make effective for the 2020 calendar year must be made by the end of the year. C corporations make NOL refund claims themselves, but pass-through businesses like partnerships and S corporations pass losses onto to owners, who will make claims. The fastest way to obtain a refund is generally by filing a tentative refund claim, but these must be filed by Dec. 31, 2020 for the 2019 calendar year. If your losses will be in 2020, start preparing to file early because you cannot claim an NOL carryback refund until you file your tax return for the year.
- Retroactive refund for bonus depreciation.
The CARES Act fixed a technical problem with bonus depreciation, a generous provision that allows companies to immediately deduct the full cost of many types of business investments. The legislation expands bonus depreciation to apply to a generous category of qualified improvement property (QIP). QIP is commonly thought of as a retail and restaurant issue, but it is much broader and applies to almost any improvement to the interior of a building that is either owned or leased. The fix is retroactive, so you can fully deduct qualified improvements dating back to Jan. 1, 2018, which may offer relatively quick refunds. Taxpayers who filed 2018 and 2019 returns before the law changed can choose whether to reflect the additional retroactive deduction entirely in the 2020 year with an accounting method change, or amend both the 2018 and 2019 returns to apply bonus depreciation for QIP in each of those years.
Is this the year to jump on low tax brackets?
At this point, we don’t yet know who the president will be for the next four years and what party will control the House and Senate for at least the next two years. We do know that we currently have some of the lowest federal income tax brackets we have seen for some time, and perhaps will see for the foreseeable future. Traditional tax planning has always focused on deferring income as long as possible. This may be the year to end such deferrals and take advantage of the low 2020 tax rates to recognize income. This can take many forms. Maybe the best example is a Roth conversion. Realizing capital gains is another consideration. For those over age 70½ or age 72, and with no required minimum distributions (RMDs) in 2020, income may be lower than normal this year. Don’t miss the chance to pay tax on income at lower rates. For those who suffered a decline in wages or earnings, the same may hold true.; recognizing more taxable income now may better allow you to take advantage of today’s low tax brackets. Those who received unemployment benefits, which were enhanced under the March 2020 CARES Act, may not have had any income tax withheld, but the benefits are 100% taxable regardless. Check to see if making an estimated tax payment will help to reduce or eliminate tax penalties.
Creating more taxable income in 2020 is not a one-size-fits-all recommendation. There are so many ripple effects to consider when increasing income. However, it would still be disappointing for your tax preparer to tell you in April 2021 that it’s a shame you didn’t have more income to make the most of low tax brackets in a year with numerous one-off planning opportunities. Start talking to your financial advisor and tax preparer today to model your 2020 tax return and compare it to what you expect your tax rates to be in the future.
Looking ahead to future estate taxes
Federal estate taxes are something many people do not have to worry about. The current estate tax exclusion is $11,580,000 per person. That means a couple can shelter just over $23 million of transfers during their lifetime or at death. The question is what the estate tax exclusion will be in the future. Under current law, the exclusion will decrease by 50% on Jan. 1, 2026. Reducing the exclusion more than 50% and sooner than 2026 has come up on the presidential campaign trail. This year presents an opportunity to review your estate plan with your advisor and estate attorney to determine if your circumstances warrant implementing strategies to take advantage of the law we know exists through the end of 2020 but whose future is uncertain.
The best tax planning is not a once-a-year event, because occasions may arise at any time to reduce the impact of taxes, not just for the current year but longer term as well. The temptation, of course, is to always minimize this year’s taxes when doing so may result in an even higher tax burden in the future. So, when you next sit down to look at your year-end tax picture, keep in mind that the right way to view tax planning decisions is in terms of your lifetime and legacy beyond that.
Claim quick disaster loss refunds.
Tax rules allow businesses to claim certain losses attributable to a disaster on a prior year tax return. This is meant to provide quicker refunds. President Donald Trump’s COVID-19 disaster declaration was unprecedented in scope, designating all 50 states, the District of Columbia and five territories as disaster areas. This means essentially every U.S. business is in the covered disaster area and may be eligible for refunds from certain types of losses. Under this provision, a business could claim a COVID-19 related disaster loss occurring in 2020 on a 2019 amended return for a quicker refund. The provision may potentially affect losses arising in a variety of circumstances, including the loss of inventory or supplies or the closure of offices, stores or plants. To qualify, the loss must actually be attributable to or caused by COVID-19 and satisfy several other requirements.