We realize that taxes may not be as exciting to you as they are to us. But before you tuck away that tax return, it’s worthwhile to spend a few minutes learning what you can from it. After all, you probably did just look at most of the financial details in your life that can have an impact on your long-term financial success.
Over the next few months, we will be working with our financial planning clients to review their 2022 tax returns with an eye towards identifying opportunities for strategies that we can implement this year – in areas such as expected 2023 income, real estate sales, Roth conversions, Required Minimum Distributions (RMDs), and charitable giving.
Even without this sophisticated approach, here are five key questions you can use to turn your tax return into opportunities in your future finances.
Does your tax return have a capital loss carry forward? If so, do you know how to take advantage of that? (And if not, why not?)
Investment accounts that are not tax-protected (in an IRA, Roth, annuity, or 529 Plan, for example) have current day tax consequences with every transaction. When an investment is sold, you may have a gain or a loss. You may also incur other taxable events, like dividends.
In years like 2022 which feature significant volatility, a key strategy is tax loss harvesting. This strategy involves selling an investment in a downturn – not to pull out of the market, but rather to generate a taxable loss and then to reinvest in another asset. This strategy is very complex, and the IRS has restrictions on what investors can reinvest in, but the end result can be a significant tax mitigation tool for investors.
As an example, last year one of our client families sold a piece of property at a substantial gain. We knew the sale was coming and were able to dive deep in their portfolio and find taxable losses as the market bounced around last year. The net result? According to their CPA, we saved them over $10,000 in taxes just by pairing their real estate gain with temporary portfolio losses.
Do you know if a Roth conversion makes sense for you?
Ideal candidates for Roth conversions are generally either people who find themselves in a very low tax bracket, those who have legacy goals, or even those who are early in their accumulation journey and may have a small retirement account from a former employer. Converting traditional IRA dollars to Roth dollars requires that you pay ordinary income tax on the converted dollars, so it does not make sense for everyone. With a future focus on our clients’ financial success, we schedule Roth conversions at financially opportune times – when the market is down, when they are in a tax desert, or before their income bumps up with Social Security and RMDs. Business owners tend to have a tax desert after the year that they sell, and this is an ideal time to create ordinary income that will be taxed at a very low rate.
The SECURE 2.0 Act, passed in late 2022, delayed the beginning age of Required Minimum Distributions (RMDs) to age 73, and eventually some to age 75! This poses a great opportunity to consider Roth conversions for those clients with a desire to enhance your legacy to children and grandchildren.
Do you take the standard deduction, or do you itemize your deductions?
The decision about how to take your deductions is unique to you and should be guided by a discussion with your CPA or tax preparer. Once you make that decision, it will inform other decisions. For instance, for our clients who go back and forth between standard and itemized depending on the year, we work with them to time their large charitable contributions for years that they itemize so that they maximize the tax benefit for the gift.
Do you donate to nonprofits?
Charitable donations are tax deductible, but – as noted above – may or may not benefit your end tax result depending on how you itemize and your total income level. One tool that can help you control the timing of your donations is a donor-advised fund (DAF), which allows you to make a tax-deductible contribution now to be held for future use. Another tool that can be used (or that you can suggest to your parent or grandparent) is a Qualified Charitable Donation (QCD), which allows those over 70 ½ to donate dollars directly to a nonprofit and avoid taxation altogether. QCDs can actually qualify as an RMD as well.
Do you know how much you spend? And where?
Chances are that you had to peruse your 2022 spending to complete your taxes. Almost every new client that comes to us underestimates their spending – by a lot. It’s worth it while your spending is fresh on your mind to think about whether that money is serving your greater goals. Are you investing enough to meet your goals? Are you overspending in certain areas? With inflation settling in for a while, do you need to make adjustments to your expenses so you can stay out of debt and maintain a healthy cash cushion?
The last few years have brought renewed focus for many on how they are spending their resources – their time, energy and money. Doing your taxes may feel like drudgery some years, but it can also be enlightening about whether your financial decisions are serving you and your life they way they should be.
If you are in need of a wealth management firm with an intentional, continuous focus on your tax strategy, contact us at firstname.lastname@example.org.
Debra Brennan Tagg is a CERTIFIED FINANCIAL PLANNER™ Professional and the creator of the DBT360 Financial Plan, a proprietary program that helps her clients prioritize their goals, leverage their resources, and address their risks. She is the president of BFS Advisory Group and teaches the public and the financial services industry about the importance of values-based financial planning and investor education.
FSC and its representatives do not provide tax or legal advice.