The importance of tax planning is often underestimated and overlooked. If not accounted for, taxes may end up eating a significant chunk of your prospective income and savings. Thus, proper financial planning is essential for achieving short-term and long-term financial goals and staying clear of any significant tax implications. Consult with a professional financial advisor who can help you make wise decisions about your taxes, assets, and liabilities, including investments, retirement plans, insurance policies, mortgages, and more. In the long run, these professionals can help save you money on taxes by employing strategies that minimize or eliminate tax liabilities.
Read more to learn the impact of financial planning on your tax liabilities.
What is tax liability?
Tax liability refers to the amount of money that you have to pay in taxes for a given tax year. It is calculated based on your taxable income, holdings, and estimated taxes. The tax is payable on all earnings and may be applicable at federal, state, and local levels.
Most people have a federal tax liability unless their income is below a certain threshold for filing a tax return. The tax liability is higher in the case of high-income individuals. Many people also don't realize that their tax liability is not just dependent on their income but also on their investments. For instance, your investments in stocks and bonds, mutual funds, real estate, etc., all attract different tax rates.
If you're unsure of your tax liabilities, you should check with your accountant or financial advisor.
How is tax liability calculated?
The calculation of tax liability for salaried individuals is relatively straightforward. Subtract the total tax deductions from your taxable income and the difference will be counted as your total tax liability.
On the other hand, tax computation may be severely complex for business owners, high-income individuals, and self-employed individuals. This can be attributed to having multiple assets and income streams. Hiring a tax advisor or a comprehensive financial planner may go a long way toward beating tax stress and minimizing your tax liabilities.
How to reduce tax liability with proper financial planning
A tax advisor or a comprehensive financial planner will assess your age, time left for retirement income, assets, liabilities, financial goals, and other aspects to design a financial plan to help you minimize your tax liability. Proper financial planning can also help maximize the amount you save for your retirement.
Some options that tax advisors suggest for minimizing tax liability include:
1. Claim all eligible deductions, credits, and exemptions
The IRS has made provisions to claim federal tax credits and deductions on income and savings, family and dependents, healthcare costs, education costs, and even investments. If you are eligible for any of these, you can claim them on your tax return and get your money back. It is also a good idea to keep track of the amount being withheld every month. Claiming all available and applicable tax credits can help minimize your tax liability.
2. Increase contributions towards retirement accounts
Saving for retirement is a common goal that most people work towards. Maxing out your annual contributions to your retirement accounts is a great way to save more for retirement and reduce your taxable income. Contribution limits and tax savings vary based on the retirement account (401k, traditional IRA, Roth IRA, etc.,) chosen by you. For instance, the money you contribute to an employer-sponsored 401(k) is deducted from pre-tax dollars, and the tax you pay on that money will depend on the rate prevailing at the time of withdrawal. On the other hand, the contributions to Roth IRA are made after paying taxes, hence, you do not pay any tax at the time of making a withdrawal.
Proper financial planning considers all factors to determine a tax strategy that best suits your financial goals and needs.
3. Make donations to qualified charitable organizations
Donating to qualified charitable organizations throughout the year can make you eligible to claim tax-deductible donations while filing tax returns. Doing so can considerably lower your tax bill.
4. Use debt to lower your taxes
Proper financial planning can help you avoid penalties and interest charges when using credit cards, loans, or other forms of debt financing. Tax laws allow many types of debt to be deducted from income in order to lower the amount of taxes owed by the borrower.
5. Sync your cash flow & file for tax refunds at appropriate time
Your cash flow may differ based on your income, type of employment, insurance plans, investments, and more. Here synchronizing your cash flow can help you employ better tax strategies.
Additionally, meticulous and accurate tax planning can help eliminate tax liabilities. This can be achieved by reducing taxable income, increasing deductible expenses, or both. Reduced taxable income can result in lower tax liability, which can translate to higher refunds. Financial planning can help ensure you file for refunds in a timely manner.
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What are the advantages of proper tax planning?
The tax benefits of proper financial planning are not just limited to the amount of money you save but also the amount of time you save. Your financial planner will advise you on how much you need to save for retirement and other important goals like buying a home, paying for college, etc.
The tax advisor can also help you develop a budget to keep track of your spending habits and ensure that each month goes as planned. When you know where all of your money is going, it can help you avoid unnecessary expenses and make sure that every dollar counts.
Should I hire a financial advisor for tax planning?
The importance of tax planning cannot be stressed enough. The tax laws are constantly changing, which means that the rules of taxation frequently change as well. However, it's also important to remember that this is a complex area of law and can quickly get out of hand if you don't seek a professional’s help. If you're not familiar with tax laws, it can be challenging to know what to do or how to proceed. That's where a financial advisor can come in handy. A good financial advisor will be able to explain how different tax strategies work and what they mean for your tax liability and your overall financial situation.
To summarize
An exhaustive financial plan takes into account your income, savings, tax liabilities, and investments to create an overview of your finances. The tax liability you pay is based on your income, available deductions, and the amount of money you have in your accounts. You may be attracting penalties if you do not pay your taxes on time or delay filing them. It is best to have a dependable financial plan in place to account for your tax liabilities and live a stress-free life. Consult your tax advisor for the proper guidance on all nuances of taxes and ensuing tax implications.
Use the free advisor match tool to match with an experienced and certified financial advisor who will be able to guide you effectively on how to reduce your taxability with the help of proper tax and financial planning. Give us basic details about yourself, and the match service will connect you with 1-3 professional financial fiduciaries that may be suited to help you.