February was FIRE (financial independence, retire early) month here on the Illumination Wealth blog. In March, we want to shift our focus to tax planning because it’s hot on everybody’s minds this time of year. This is especially true in 2019 because we’re all filing our first tax returns under the new Tax Cuts and Jobs Act system.
The truth is that financial independence and strategic tax planning should go hand in hand. Taxes are likely the largest expense in your budget. Being wise with how you manage your taxes will make a huge difference if you have goals of financial freedom and early retirement. Some of these strategies may help as you file your 2018 tax returns, but most are future planning ideas that you can implement for 2019 and beyond. We call it “tax planning” for a reason.
Increasing how much you donate to charity should make you feel good on two levels. First, you are donating money, vehicles, property and even stocks to benefit those who may be less fortunate. Second, the tax deductions for charitable contributions are great. Be sure and document all deductions and take the time to understand what can and can’t be deducted when you file your taxes. There’s a great charitable investment tool called a Donor Advised Fund that you should explore as well.
Of course, 401k contributions are done pre-tax and will not count toward your taxable income for the year. Divert some of your extra earnings into your retirement savings account(s). At year’s end, max out your contributions if you haven’t already. You will be able to put more away for retirement while also reducing your taxable income for the year.
In addition to 401k contributions, there are other strategic ways to safely defer your income. This includes prepaying expenses at year end or sending December invoices at the very end of the month because the income won’t count until the payment is actually received the following year. Talk with your financial advisor about other methods of differing income that might benefit your personal situation.
Consider liquidating any securities or property that have been on the decline. Remember that only investment property losses can be written off (depending on your annual income) and you also have to look at your capital losses and gains. You are only allowed to deduct up to $3,000 a year in capital loss deductions, so know your options and make the right strategic moves as part of your tax plan.
Whether you do it toward the end of the year or all year long, increasing your withholdings will be beneficial to your tax liabilities. This reduces the risk of owing more when you file your taxes. In most cases, it will lead to a larger return. A trusted tax advisor will be able to help you determine what withholding will be best for your tax plan.
It’s a good idea to always keep a close eye on your flex spending account. Understand your options if you’ve spent too much or haven’t spent as much as you expected. Mismanagement of an FSA can lead to lost money. At the same time, you may find some tax benefits if you manage this account strategically for both health care and childcare.
If you own a business—and especially if you are preparing to start a new business—it pays to structure it the right way as an S-Corporation, C-Corporation, LLC or Sole Proprietorship. Each will have some pros and cons when it comes to tax liabilities and benefits, so do your research and strategize with your financial advisor to make wise business decisions.
These are just a few ways to improve your tax planning and overall wealth management strategy. Ultimately, the goal is to achieve financial independence and how you manage your taxes is a major part of your journey.
For help with your tax planning and overall financial life plan, contact Illumination Wealth today.