The next step in the financial planning process is tax planning. A solid tax plan considers all forms of taxation, with steps taken to reduce, defer and otherwise not pay any more than you are legally required to pay.
Too many families let taxes drive their plan, and avoid making certain financial decisions simply due to the tax consequences. Taxes are certainly a factor to consider, but may not be the most significant issue. When looking at this year';s information, develop an eye toward how you may make your income or deductions more tax-appealing for your 2012 return. By the time many taxpayers file their 2011 returns, 2012 will be at least 25 percent over. That means that the time to plan your 2012 tax strategy is now.
You may look to reduce your taxable income by finding ways to defer or eliminate income from your return. Common deferral techniques include stuffing as much as you can afford into retirement plans or Roth IRAs or 401(k)s. Another popular tool is the use of annuities. Deferred annuities allow your gains to avoid taxation while you earn, and you pay taxes on the earnings when you eventually withdraw the money. Deferral is a double-edged sword, however. It can cut both ways because of future unknowns - like what your income tax rate will be when you do eventually withdraw the funds.
For the time being, long-term capital gains still enjoy favorable tax treatment. In general, looking to generate as much income as possible as long-term capital gains is more tax-efficient than ordinary income under the current tax structure. So with capital gains tax rates on the low end of their historical range, this may be a good time to create gains.
I';ve seen too many investors refuse to sell positions due to the tax consequences of that action.
On the deduction side, the best planning frequently involves timing. It is too late for most people to make any payments now that may affect last year';s tax returns. The exception for some may be contributions to IRAs and certain other retirement plans for the self-employed.
The best way to start a tax plan is to look at your prior year';s return, and create a second column for what you expect on each line item for the current tax year. With the guidance of a tax-savvy financial adviser or CPA, you should begin to gain clarity on what it will take to improve your tax position for next year';s return.
John P. Napolitano is the CEO of U.S. Wealth Management in Braintree, Mass. He may be reached at jnap@uswealthcompanies.com.
