YOUR MONEY
Tax-Plan Now
To Save Later
By Bill DeMarco
You don’t want to pay more federal income tax than you have to. Here are three ways to keep more of your money:
- Postpone your income to minimize current income tax liability
Deferring income to a later year may minimize your current income tax liability. When you eventually report the income, you may be in a lower income tax bracket.
Some retirement plans can help you postpone taxes on your earned income. With a traditional 401(k) plan, for example, you contribute part of your salary into the plan, paying income tax only when you later withdraw money from the plan (withdrawals before age 59½ may be subject to a 10 percent penalty tax in addition to regular income tax, unless an exception applies). This allows you to postpone tax on part of your salary and take advantage of the tax-deferred growth of any investment earnings.
There are many other ways to postpone your taxable income. You can contribute to a traditional IRA, buy permanent life insurance (the cash value part grows tax deferred), or invest in certain savings bonds. Speak with a tax professional about your tax planning options.
- Shift income to family members to lower the overall family tax burden
You may also minimize federal income taxes by shifting income to family members who are in a lower tax bracket. For example, if you own stock that produces dividend income, one option might be to gift the stock to your children. After you’ve made the gift, the dividends will represent income to them rather than to you, potentially lowering your family’s overall tax burden. Keep in mind that you can make a tax-free gift of up to $17,000 (in 2023; $16,000 in 2022, and could increase in future years) per year per recipient without triggering federal gift tax.
Other ways of shifting income include hiring a family member for the family business and creating a family-limited partnership. Investigate your options carefully before acting.
- Timing Counts with Investments
You can also minimize tax by making tax-conscious investment choices. Potential strategies can include the use of tax-exempt securities and intentionally timing the sale of capital assets for maximum tax benefit.
Although income is generally taxable, certain investments generate income that’s exempt from tax at the federal or state level. For example, if you meet specific requirements and income limits, the interest on certain Series EE bonds used for education may be exempt from federal, state and local income taxes.
Also, you can exclude the interest on certain municipal bonds from your income (tax-exempt status applies to income generated from the bond; a capital gain or loss realized on the sale of a municipal bond is treated like a gain or loss from any other bond for federal tax purposes). If you earn interest on tax-exempt bonds issued in your home state, the interest will generally be exempt from state and local tax as well. Keep in mind that although the interest on municipal bonds is generally tax-exempt, certain municipal bond income may be subject to the federal alternative minimum tax. When comparing taxable and tax-exempt investment options, you’ll want to focus on those choices that maximize your after-tax return.
Usually, long-term capital gain tax rates are lower than ordinary income tax rates. That means that the amount of time you hold an asset before selling it can make a big tax difference. Since long-term capital gain rates generally apply when an asset has been held for more than a year, you may find it makes good tax sense to hold off a little longer on selling an asset that you’ve held for only 11 months. Timing the sale of a capital asset (such as stock) can help in other ways as well. If you expect to be in a lower income tax bracket next year, you might consider waiting until then to sell your stock.
Bill DeMarco is an investment advisor representative with A&M Financial Group in Westlake. You can reach him at 440-249-0397, ext. 106 or go to amfinancialgroup.com. Advisory Services are offered through AMFG Wealth Management LLC, a Registered Investment Advisor. Note: You should not decide which investment options are appropriate for you based on tax considerations alone. Nor should you decide when (or if) to sell an asset solely based on the tax consequence. A financial or tax professional can help you decide what choices are right for your specific situation.
Photo by Diane Helentjaris on Unsplash
