How Your Financial Decisions Affect Your Taxes

How Your Financial Decisions Affect Your Taxes

February 24, 2021

Tagged As: Personal

‘Tis the season to talk tax!  By keeping an eye on the tax consequences for your everyday financial decisions, you could potentially lower your tax bill. This article will discuss a few generalized tax-advantage savings possibilities.  Tax savings opportunities will vary from person to person - please consult your tax advisor regarding your particular tax situation.

Retirement Account Contributions

Retirement savers have a variety of options to maximize tax savings.  Whether you choose to save on taxes now or in the future depends on the type of retirement account you utilize.

Tax-deferred retirement account:  is a retirement account that allows a taxpayer to delay paying taxes on the money invested until it is withdrawn, generally after retirement.  An employer-sponsored 401(k) and traditional IRA are two common types of tax-deferred savings plans.

Your contributions to an employer-sponsored tax-deferred account are excluded from income taxation at the time of deposit.  Similarly, contributions to a traditional IRA are deductible on your income taxes up to the limits established by the IRS.  Therefore, your contributions to tax-deferred retirement accounts can reduce your income and as a result, can reduce the amount of income tax you owe.

Tax-free retirement account: is an individual retirement account that offers tax-free growth and tax-free withdrawals in retirement as long as rules set forth by the IRS are met.  The only type of tax-free retirement accounts are a Roth IRA or a Roth 401(k).  The account is funded with after-tax money and grows tax-free and remains tax-free when withdrawn in retirement as long as the rules are followed.

Non-Retirement Account Investment Planning

Investment decisions have tax consequences, and minimizing taxes can be part of your overall investment strategy. The investment risk you’re willing to take, returns you can reasonably expect, portfolio diversification and transactions are all important factors of your investment strategy.

Here are terms commonly discussed in non-retirement investment accounts:

  • A capital gain is money you earn from selling an investment for more than you paid to buy it. A capital loss occurs when you sell an investment for less than it cost you.
  • If you've owned an investment for more than a year before you sell, you have a long-term capital gain or loss. If it's been less than a year, you have a short-term capital gain or loss.
  • Long-term gains are taxed at a lower rate than your ordinary income, while short-term gains are taxed at your ordinary income rate. The long-term rate is determined by your adjusted gross income (AGI), and may be 0%, 15%, or 20%. Surcharges may apply, again depending on your AGI.
  • You can use long-term capital losses to offset long-term capital gains, or short-term losses to offset short-term gains, on a dollar-for-dollar basis. There is a limit to the amount of loss you can take per year- unused losses can be carried forward indefinitely until the amount is exhausted.

So, as you make investment decisions, you may want to take into consideration capital gains and losses.

Making decisions like these can be easier with the help of a dedicated Wealth Management Professional.

Avoid a Wash Sale

Generally, a wash sale occurs when you sell a security at a loss and buy the same or “substantially identical” security within 30 days before or after the sale date.   If your investment transactions create a wash sale, your tax loss will be disallowed.  Wash sales only transpire in a taxable investment account.  Wash sales do not apply in retirement accounts.  A wash sale can also occur if you obtain a contract or option to buy substantially identical stock or securities

Using Pretax Dollars

If your employer offers a healthcare plan that is eligible for a flexible spending account (FSA) as an optional employee benefit, it's a tax-saving opportunity you might not want to pass up.  An FSA is a savings account that lets you set aside pretax income to pay for eligible out-of-pocket healthcare costs.  Funds contributed to the savings account are deducted from your earnings before taxes, lowering your taxable income.  Therefore, regular contributions to an FSA can lower your annual tax liability.  There are limitations to the amount you can contribute.

Money set aside in an FSA generally must be used by the end of the plan year on eligible expenses or you may forfeit it.

Charitable Giving

Charitable giving can provide many benefits, from a sense of fulfillment and goodwill towards others, to helping you minimize taxes.  There are many charitable giving strategies that can potentially help you reduce taxes, lower your taxable estate, or reduce capital gains.  The IRS sets very specific guidelines for allowing a charitable donation to be tax-deductible.  Consult with your tax adviser to learn what strategies may work best for your tax situation.

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