As a business owner, we are constantly looking for ways to effectively use the tax code in our favor, whether it be the effective use of business deductions or depreciation on vehicles. W-2 employees do not have this same ability and are limited to either itemizing their deductions or using the standard deduction. Whatever the case may be, here are a few tax ideas to consider headed into the New Year.
- Portfolio Allocation: When I mention portfolio allocation, I am not referencing how the portfolio is invested, be it a 60/40 diversified portfolio. We are more concerned about what it is invested in and how they are invested. For example, a large “capital gains distribution” will be paid on behalf of mutual funds this year while clients effectively see negative returns in their portfolios. What does this mean? It means they will have to pay taxes when their portfolios lost money. It may be time to consult with an advisor and reevaluate your allocation in your non-qualified accounts to reduce your taxes by moving those assets into ETFs (exchange traded funds), or a tax-efficient portfolio that is built by your advisor or a company. (Mutual Fund Double Whammy)
- Marginal Tax Bracket: Your tax return often tells you the marginal tax bracket, which is the marginal rate at which the next $1 of ordinary income will be taxed. If you fall into the 24% bracket, most believe all of their income is taxed in that very bracket which is not the case. For example, we have noticed most people in the marginal 22% bracket to have an average rate of 14.3%. There is also a concept of effective rate, which is often included on reports from tax professionals and is calculated by taking the total tax divided by taxable income after deductions.
- When we know the marginal rate, we can make great decisions. If we have some disposable income, we can use the marginal bracket to possibly consider a Roth conversion and now have after tax growth and income that bypasses RMDs.
- HSA Contribution: If you have not heard of this amazing little tool please familiarize yourself with the Health Savings Account. The HSA is a powerful little known element of the financial planning arena where you can put money into an account tax deferred, and then take it out tax free to cover qualified medical expenses. If you have access to this account, we believe contributing money into it not provides an above the line deduction, but also creates a bucket of dollars that are likely not to be taxed again.
- Maximize Above-The Line Deductions: Most may or may not understand this little tax maneuver, but it is important to maximize the above the line deductions. The most common ones you will see are traditional IRA contributions, HSA Contributions (there’s that word again), qualified retirement plan contributions, and here’s one, penalties on early withdrawals of savings. The reason this is so important is strictly due to the fact most people will not itemize their below-the-line deductions and usually take the standard deduction due to the amount.
- Tax Loss Harvesting: After nearly a decade of gains and nothing but gains within many accounts, it is now time for us to tax loss harvest. You may be able to take $3,000 of losses to help offset taxable capital gains, and/or ordinary income. Many should have the ability to tax loss harvest this year which may provide significant carry-forward losses against future gains. Furthermore, you may be able to swap those securities for others and avoid the nasty wash sale rule as well. To figure out how to do that effectively, I would consult with a tax professional and/or a financial advisor to help you make those decisions.
As a financial planner, we take serious pride in helping our clients build wealth efficiently. That is why tax planning is a huge component of the process, and is the reason we delve deep inside tax returns during the process. We believe the effective use of marginal brackets, building up pre and post-tax savings accounts, and maximizing our take home amount is critical. Although we do not prepare taxes, knowing what the tax return is saying and projecting what the future may look like with increases in income allows us to plan effectively.
9I Capital Group LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.