As the end of the year is approaching, it's high time to dive deeper into those smart tax planning strategies. Remember, it's not just about trimming down this year's tax bill. We're playing the long game here – aiming for lifetime tax savings.
Whether you’re a business owner, managing income from equity compensation, or having significant life changes that impact your income, there are multiple strategies to maximize tax benefits.
Typical Situations for Varying Income
For the Business Owners
Business owners often experience income ups and downs, from early struggles to growth and stability phases. Unexpected events can also impact income, creating unique opportunities for strategic tax planning as long as cash flow remains stable.
For Employees with Equity Compensation
If you receive equity compensation like ESPPs, RSUs, NSOs, or ISOs, these are prime tax planning opportunities. While high-income years usually call for strategies to lower taxable income, sometimes it may be beneficial to increase taxes slightly to avoid Alternative Minimum Tax (AMT) complications later on. This approach can support tax-efficient investing for those with fluctuating income from equity-based compensation.
Life changes
Major life events often bring temporary income changes. A promotion, layoff, inheritance, or time off for family can impact your income trajectory. These shifts create tax planning opportunities to lower overall tax impact, making it essential to adjust your strategy according to your current income bracket and tax year goals.
Tax Planning Strategies
Choosing Roth or Pre-tax 401(k) contribution strategically
Choosing between Roth and pre-tax 401(k) contributions can be strategic:
Higher Income Years: Consider pre-tax 401(k) contributions to reduce taxable income.
Lower Income Years: If cash flow allows, Roth 401(k) contributions could be more advantageous, helping you take advantage of lower tax rates and ensuring tax-free withdrawals in retirement.
Pay Attention to Income Limit
Roth IRAs and IRAs are a valuable tool to save for retirement, but if you have higher income or lower income, what you typically do every year could end up being a hassle to unwind.
If you have high income in the current year and you typically make IRA/Roth IRA contributions, make sure your income would not disqualify you. If you do, you could have your hands full to unwind and recharacterize during tax filing. Or, you could find yourself making pre-tax IRA contribution that locks up your money and doesn't give you tax break.
Check the income limit here:
Roth Conversion
Lower-income years can be ideal for a Roth IRA conversion strategy, allowing you to convert pre-tax contributions to Roth without incurring a high tax rate. Be prepared to pay the tax on conversion with spare cash rather than withholding from the conversion amount to avoid penalties if you're under 59 1/2.
Brokerage Tax Harvesting
Harvesting tax losses or gains can be a strategic move.
In your low-income year? Harvest tax gains.
In your high-income year? Harvest tax losses. Be particular careful when you harvesting tax losses and avoid wash sale rule.
Consider Using A DAF
For regular donors, Donor-Advised Funds (DAFs) offer an efficient way to maximize tax deductions in high-income years. A DAF lets you pool contributions for an immediate tax break while supporting causes over time.
Strategies for Business Owners
Timing Your Retirement Contributions
For the small business owners out there, determining the right amount for retirement contributions often waits until the final curtain call after the year-end. The silver lining? Plans like SEP IRA and Solo 401(k) offer the flexibility to contribute in the following calendar year, before the tax filing deadline.
Just remember: set up Solo 401(k) before 12/31 if you want to utilize it for the current tax year.
*Solo 401(k) employer contribution is allowed after 12/31. Employee deferral needs to be before 12/31.
Time Your Income and Expenses
Managing a business’s cash flow can play an essential part in your tax planning strategy.
In years with higher profits, consider delaying income recognition or accelerating deductible expenses. Only use your expenses if it’s absolutely necessary. (If you spend 10 dollars on office supply that you don’t need, to get a 3 dollar tax benefit, that’s still net 7 dollars gone. )
Conversely, in leaner years, you might want to accelerate income and defer expenses. It's all about optimizing your taxable income to your advantage.
Extra Nuggets for Business Owners
Pondering an S-Corp election? It's a move worth considering for its potential tax benefits. Also, the Qualified Business Income Deduction – a valuable tax break for many – is set to expire in 2025, so make sure to make the most of it while it lasts.
Wrapping It Up
End-of-year tax planning offers valuable opportunities regardless of your current income level. Strategic tax planning is a year-round effort, but these tactics can lower your lifetime tax burden significantly. Keep cash flow top of mind to ensure that any tax strategy aligns with your overall financial health.
Cheers to effective tax planning and long-term savings!
Disclosure:
All written content on this site is for informational purposes only.Opinions expresses herein are solely those of Savor Financial, a Core Planning brand.All information and ideas should be discussed in detail with your individual advisor prior to implementation. Investment advisory services are offered through Core Planning, LLC.The presence of this website on the internet shall in no direct or indirect way be construed or interpreted as a solicitation to sell or offer to sell investment advisory services.The information contained here is general in nature and is not intended as legal, tax, or investment advice. Further, the information contained herein may not be applicable to, or suitable for, the individuals’ specific circumstances or needs and may require consideration of other matters.CP does not provide legal advice or drafting services. Estate planning is considered incidental within the context of a financial plan. We will coordinate with your family attorney of choice. CP is not a certified public accountant and does not provide ta
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