Stay informed and flexible... So how do you navigate this complex, shifting, and often confusing maze of tax laws? More importantly, how do you best take advantage of these changing laws in order to improve your financial life and accomplish your family's dreams? The first key to making the most of changing tax laws is to stay informed and be flexible. That's not easy at first blush. It's the rare taxpayer who has the time or knowledge to monitor or comprehend all the nuances of the tax code. Are you aware, for example, that changes in the tax code in recent years have:
Still, at least you can keep up on the basics of the changes and how the changes might affect your financial life. There is plenty of information in newspapers, magazines, brochures and online that discusses new tax laws and regulations. FPA itself provides such information for the public. In addition, talk to your tax adviser, whether it is your accountant, financial planner or other professionals that you trust are knowledgeable about both tax laws and about your personal financial situation. And don't forget your own changing personal circumstances. Life changes such as marriage, divorce, death, or the birth of a child can have as profound an impact on your tax liabilities as tax law changes — sometimes more so. It's challenging, but well worth the effort. Avoiding costly tax mistakes and taking advantage of available tax breaks can save you hundreds or thousands of dollars every year. ...But don't let taxes dominate While keeping up with tax changes is important, don't let tax laws dictate your financial life. Fundamental money management principles are always in style, such as the need to save and invest, to budget, to be properly insured, and to have estate and retirement plans. Consider the challenge of saving for college education. Tax laws, particularly since 1997, have created an abundance of tax breaks and benefits for funding college education. Nevertheless, they haven't altered the underlying principle of college planning: the smartest way to pay for your children's college education is to save regularly! It's also wise not to base your tax and financial planning too heavily on what you think future tax laws might be. While it can be prudent to consider their potential impact, proposed tax law changes often have a way of never materializing or materializing in a significantly different version. Don't confuse tax preparation with tax planning Most families think about taxes only when they, or a professional tax preparer, sit down to complete their federal, and maybe state, income tax return for the previous year. That's "after the fact" tax planning. By then, it's too late to take certain tax deductions and credits based on strategies that needed to have been implemented during the tax year. Unlike tax preparation, tax planning is a year-round process. Most tax-saving strategies must be carried out no later than December 31 of that tax year, and often well before that. Examples include selling losing investments to offset other income, making certain retirement plan contributions, and taking actions that realize valuable medical and charitable deductions. Especially critical these days is planning for the dreaded alternative minimum tax (more on this later), which is hitting even middle-income taxpayers. The same advanced planning process applies to estate taxes. Failure to establish and revise plans well before death or possible incapacity could cost your beneficiaries thousands of dollars. And don't overlook other types of taxes such as property, sales and payroll taxes, which can present tax-planning opportunities. Good year-round tax planning also requires good year-round record keeping. You need to be able to substantiate your claims or else you may lose out on valuable tax deductions. Time-honored tax-saving strategies While tax laws change frequently, taxpayers can generally count on certain tax-saving strategies and principles that have endured over the years, such as deduct, divert, convert, and defer. Here are a few, and your financial planner can identify many more:
Don't let taxes control investment decisions Taxes can eat away a significant portion of an investment's return. Yet at the same time, financial planners caution against allowing the "tax tail to wag the investment dog." Investment decisions should be based first on the economics of the investment — its risk, the likely direction of its future returns, and whether it fits your current investment plan. Tax planning should be coordinated with investment planning as a secondary consideration. For example, the reluctance to pay capital gains taxes on stock profits accumulated during the bull market of the late 1990s, resulted in many investors hanging on to losing stocks during the bear market of 2000–2002. Nonetheless, numerous tax strategies and techniques can reduce the tax bite on your investment returns without compromising the investment itself: Employ certain estate planning techniques. Tried-and-true techniques such as annual tax-free gifting or the gifting of appreciated assets can save substantial estate and income taxes. Avoid common tax-filing mistakes As with time-honored tax-saving strategies, there are common tax-filing mistakes that seem to snag taxpayers year in and year out, regardless of the changing tax code: Taking the standard deduction instead of itemizing. A U.S. General Accounting Office study estimated that roughly two million taxpayers overpaid their taxes an average of $500 each by failing to itemize for such things as their mortgage interest and charitable deductions. Should you use a CFP professional for your taxes? Over half of all taxpayers have their taxes prepared professionally, according to the IRS. Many CFP professionals are among those who prepare taxes. But where a CFP professional can be especially helpful is through more long-range tax planning. As observed earlier in this brochure, many tax-saving techniques must be completed during the tax year. Your planner can make tax projections and identify appropriate strategies in time to carry them out. But even more important is that this tax planning is done in the context of your overall financial picture, which your planner knows well. That way, a given tax-saving strategy can be implemented that supports all of your important financial goals. Tax planning for life Ultimately, smart year-round tax planning is less a goal in itself than a means to help achieve the personal goals of your life. Each saved tax dollar frees that dollar for such goals as funding a comfortable retirement, putting children through college, buying a business or a dream home, taking an exotic vacation, or leaving money to heirs. Saving taxes should complement, not dominate, your financial life. By paying attention to your taxes year-round instead of just at tax-preparation time, you can make the most of tax planning strategies and, more importantly, enhance the quality of your overall financial well-being. |