Why Financial Planning Requires Tax Planning
Why Financial Planning Requires Tax Planning
"Nothing is certain except death and taxes."
This famous quote, penned by Benjamin Franklin in 1789, still rings true today. Putting aside the death aspect of that quote, the fact is, taxes infest every area of our financial lives: state and federal income taxes on the money we earn from our jobs, capital gains taxes on the sale of investments and assets, corporate and payroll taxes if we own a business, sales and use taxes on nearly every item and service we purchase, excise taxes, vehicle taxes, gas taxes . . . you get the picture.
Tax burdens are such a large part of our financial lives that, for many years now, groups have been calculating "Tax Freedom Day" – that is, the day on which the nation, as a whole, has earned enough to "pay" its tax bill at the federal, state, and local level, for the year. For 2023, that day has been calculated as April 18. That's right: Americans spend three and a half months of their working year laboring to support the government. In general, Americans spend more on the total taxes they pay in a year than on the total they spend on food, clothing, and shelter in that same year.
When you realize these facts, it requires very little analysis to conclude that: of course financial planning should include tax planning. Taxes have a critical impact on our financial well-being.
What Might Tax Planning Entail?
The tax code is enormously complicated. There are enough loopholes, credits, exclusions, and exceptions in the tax code that tax accountants have very little trouble staying employed. But the bottom line for every taxpayer is this: if you can legally avoid paying taxes to keep the money yourself instead of paying Uncle Sam and your state, you should do it.
The simplest aspect of tax planning is taking advantage of tax shelters – essentially, places to park your income so that it can be used by you but without being taxed. These may come in many forms. Some have tax advantages now, and others have them later when used for retirement or another specific purpose. Programs like your employer's 401(k) retirement plan or the different types of IRAs are easily accessed shelters. Another is depositing funds into an HSA, where the funds can be invested or used for medical expenses. Another shelter is to put funds in your child's 529 education savings account. 529 accounts have no federal tax advantages, but they do have state tax advantages. Other investments might include certain municipal bonds, in which the investment returns may be free from state and federal taxation.
In addition to being able to reduce your taxable income either now or in the future, another tax planning tool is to find out what tax deductions and tax credits may be available to you to reduce your tax liability. These can include child tax credits, other dependent tax credits, charitable contributions, American opportunity tax credits, home office deductions, student loan interest deductions, mortgage loan interest deductions, and so on. If you own a business, there are other types of credits that you can take. Taking advantage of available credits and deductions can leave more money in your wallet when tax time rolls around.
Tax Planning Can Significantly Impact Your Finances
Additional tax issues can affect your financial situation beyond your annual tax returns. These might relate to your overall investment choices, how and when to liquidate certain investments, how to structure your estate to avoid estate taxes down the road, what sorts of expenditures can yield tax benefits, whether taking out a loan has tax advantages, and so on. Especially for those with high-income or significant assets, tax planning can become pretty complex, but it is a critical aspect of financial planning.
But even at the level of someone with a relatively moderate income, good tax planning and understanding of the tax ramifications of your financial decisions can amount to thousands of dollars that could be used to benefit you and your family versus those same thousands being paid to cover the tax liability. Over time, those thousands of dollars add up and can make a considerable difference in the quality of your life both now and in the future.
At Mountain Financial, we offer our clients a full suite of financial planning advice, including information about different tax planning strategies. For more information about how we can assist you with tax planning or how incorporating some tax strategies into your financial plans can help you build wealth, don't hesitate to get in touch with Mountain Financial today.
