By Clayton Johnson, CFP®
Tax planning is an essential aspect of personal finance and business management. With the appropriate strategies, you can legally minimize your tax liabilities and keep more of your hard-earned money. Here are 5 tax planning strategies to help you reduce your tax liability.
1. Tax Loss Harvesting
Tax loss harvesting is usually accomplished with stocks/mutual funds/ETFs in taxable investment accounts. To harvest losses for tax purposes, you sell investments that are down, replace them with reasonably similar investments, and then use those losses to offset realized investment gain on your tax return.1 The benefit is that your money stays invested, and you get to offset some gain in the current year. We saw a lot of opportunities for this in 2022.
2. Donating Appreciated Stock
Donating appreciated stock involves giving stocks or other securities in a taxable account that have increased in value to a charitable organization, rather than selling them and donating the cash proceeds. This can provide a tax advantage because the donor can generally deduct the full value of the donated stock as a charitable contribution while avoiding capital gains taxes on the appreciated value of the stock.2
3. 401k Contributions
Making tax-deferred contributions to a 401k plan can provide several tax benefits. First, the money you contribute to your 401k is deducted from your taxable income in the year of the contribution, reducing the amount of income taxes you owe for that year. Second, any earnings on the funds in your 401k account grow tax-deferred, meaning you won’t owe taxes on them until you withdraw the funds in retirement. Finally, if your employer offers a matching contribution to your 401k, that is essentially free money that you can receive without paying taxes on it up front.
4. Health Savings Account (HSA) Contributions
Contributing to an HSA can provide several tax benefits. First, contributions made to an HSA are tax-deductible, meaning they reduce your taxable income for the year in which you make the contribution. Second, any interest or investment earnings on the funds in your HSA grow tax-free. Third, if you use the funds in your HSA for qualified medical expenses, you won’t owe any taxes on those withdrawals. For more details on the fantastic, tax-free benefits of an HSA, you can check out our video here.
5. Charitable Bunching
Charitable bunching is when you combine several years’ worth of charitable donations into a single tax year. By doing this, you can itemize your deductions in the year of the bunching and then take the standard deduction for the other years. If your itemized deductions are typically close to the standard deduction, this approach usually means paying fewer taxes than if you itemized every year. This strategy can be particularly effective when used in conjunction with a donor-advised fund.
Effective tax planning involves reviewing your financial situation, understanding tax laws and regulations, and taking advantage of available deductions, credits, and exemptions. It’s also important to stay up-to-date with changes in tax laws and seek professional advice when necessary. By implementing these tax planning strategies, you have the potential to achieve significant tax savings and improve your financial well-being.
1https://www.fidelity.com/viewpoints/personal-finance/tax-loss-harvesting#:~:text=Tax%2Dloss%20harvesting%20allows%20you,invested%20and%20working%20for%20you.