What is Tax Planning?

In business they say, things that are measured do well, and things that are measured and reported do tremendously better. Sadly, most taxpayers skip to the reporting and never do the measuring! You have to pay your taxes and you have to do tax reporting. Tax planning is an extra step offering significant value for your financial journey. Tax planning is the “measuring” and must be done before the end of the year. This is where you adjust investments and income to maximize your tax opportunities.

You’ve probably heard Einstein’s definition of insanity, which is when you do the same thing over and over, and you expect a different result. That’s what happens almost every year with most people’s tax return. They do not make any changes or do anything different. They do not do any proactive tax planning, but they hope for different results! Suddenly, April 15th rolls around and you have to pay the IRS. The tax season is an ongoing annual process of frustration.

You can’t make any changes – short of IRA contributions – after December 31st. April 15th is 112 days into the next year, so it’s not front and center on your mind around the holidays. But it should be if you genuinely care about your retirement. It’s your financial journey and tax planning is necessary for success.

Think about our progressive tax system as a series of stair steps. The more you earn, the higher up the steps you go starting from 0% moving all the way up to 37%. The first objective in tax planning is to know your marginal and effective tax rates. The effective rate is what you pay on the average dollar you earned. The marginal rate is where your last dollar was taxed. You recognize the taxation on each of the steps along the way making your average tax rate lower than your marginal rate. When doing financial planning, it is the marginal rate that matters most.

If you are married filing jointly, your first $19,000 of earnings after your deductions will be taxed at 10%. Then, you’re going to take a step up and it will be a 20% increase to the 12% bracket and so forth. The goal is to stay in that 12% bracket or lower whenever possible as there are significant tax advantages at those rates.

With the changes beginning January 1st, 2018 to the tax, many taxpayers will find themselves no longer itemizing. That changes many tax planning opportunities, but it doesn’t shut the door on good planning. There is still Bracket Bumping, Double Stacking, Qualified Charitable Distributions (QCDs) and gifting strategies that can be explored.

Tax reporting is what you do every April. Tax planning is what you have to do before the end of the year. Don’t miss the deadline. You’ll be disappointed in the years to come when you recognize what opportunities you missed.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see our Disclosure page for the full disclaimer.