Tax planning is the art of arranging your affairs in ways that postpone or avoid taxes. By employing effective tax planning strategies, you can have more money to save and invest or more money to spend. Put another way, tax planning means deferring and flat out avoiding taxes by taking advantage of beneficial tax-law provisions, increasing and accelerating tax deductions and tax credits, and generally making maximum use of all applicable breaks available under our beloved Internal Revenue Code. While the federal income tax rules are now more complicated than ever, the benefits of good tax planning are arguably more valuable than ever before.
Of course, you should not change your financial behavior solely to avoid taxes. Truly effective tax planning strategies are those that permit you to do what you want while reducing tax bills along the way. Financial planning is the art of implementing strategies that help you reach your financial goals, be they short-term or long-term. That sounds pretty simple.
However, if the actual execution was simple, there would be a lot more rich folks. Tax planning and financial planning are closely linked, because taxes are such a large expense item as you go through life. If you become really successful, taxes will probably be your single biggest expense over the long haul. So planning to reduce taxes is a critically important piece of the overall financial planning process. There are many other ways to commit expensive tax blunders. Like selling appreciated securities too soon when hanging on for just a little longer would have resulted in lower-taxed long-term capital gains instead of higher-taxed short-term gains; taking retirement account withdrawals before age 59½ and getting hit with the 10% premature withdrawal penalty tax; or failing to arrange for payments to an ex-spouse to qualify as deductible alimony; the list goes on and on.
The cure is to plan transactions with taxes in mind and avoid making impulsive moves. Seeking professional tax advice before pulling the trigger on significant transactions is usually money well spent. As we get closer to the end of the year, some of my columns will focus on tax planning strategies that many folks can benefit from. Please stay tuned.