Time to Brush Up on Tax Planning Fundamentals

Susan P. Stutzman, CPAWith all the media buzz about tax increases in proposed legislation, many are taking a fresh look at their finances to determine ways to minimize their tax liability. “Truthfully though, comprehensive tax planning should be an ongoing, year after year endeavor,” says Susan Stutzman, Director, Tax Strategies at Kreischer Miller.

Most tax planning is focused on specific events happening in a taxpayer’s life, such as buying or selling a business or other property, making a life transition such as retirement, or making investment decisions. We interviewed Stutzman for the July issue of Insights from Kreischer Miller about the importance of ongoing tax planning and how it can help minimize taxes and maximize cash flow each year.

What are the fundamentals of tax planning?

The basic fundamentals of tax planning fall into the following categories:

  • Changing the nature of your income or deductions
  • Changing the timing of your income or deductions
  • Transferring income to another entity or person

Can you provide more insight into each of these fundamentals?

Here are some specific examples regarding the above categories.

You can change the nature of your income by:

  • Investing in municipal bonds (which offer tax-free interest) as opposed to investing in a bank savings account or certificate of deposit.
  • Making contributions to a health savings account, which are deductible against gross income (or pre-tax if made through an employer plan). If you instead paid medical expenses outright, you may be subject to significant limitations as itemized deductions. Or, if you claim the standard deduction, you would receive no additional benefit.
  • Investing in securities that generate qualified dividends which are currently taxed at a lower tax rate than interest.

If you delay recognizing income or accelerate deductions, you can defer the payment of tax to a later year and realize savings based on the time value of money. By deferring the payment of tax, you can make your money work for you longer by earning interest or dividends.

Additionally, in an environment with projected changes in tax rates and brackets, you could move income into a period with a lower tax rate or move deductions into a period with a higher tax rate to save taxes. With proposed increases in tax rates, it may actually be prudent to accelerate income and defer deductions.

You can also lower taxes by transferring income to another type of entity:

  • Small businesses can choose from a variety of structures in which to operate. Each structure has pros and cons, so you should carefully assess your options to determine the optimum structure from a tax, legal, and operations standpoint. However, significant tax savings can be achieved.
  • Individuals can gift assets to someone in a lower tax bracket, although it is important to be mindful of the kiddie tax rules. Gifting transfers assets and may also reduce estate and inheritance taxes in addition to income taxes.

What other considerations should individuals and business owners think about?

There are many factors to consider when making tax planning decisions, such as future income levels, expected future tax rates, and time value of money. It is also important to consider all taxes that could apply, not just federal income taxes. State income taxes as well as estate and/or inheritance taxes can also have a significant impact on your decisions. Tax rates are currently at record low rates, but probably not for long.

It is important to always consider the overall economic consequences of tax planning moves. While the tax savings could be significant, if you incur an overall economic loss or it is something that you are not comfortable with, then it doesn’t make sense to do something just to save taxes. Each individual has their own unique circumstances, and all of this should be considered when preparing any comprehensive tax plan.

Susan P. Stutzman can be reached at Email or 215.441.4600.

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