Tax planning is a focus for all seasons

Bill Cass, CFP®, CPWA®

Bill Cass, CFP®, CPWA®, 04/19/23

With tax season over, some taxpayers may want to forget out about taxes until next year. Tax issues, however, should remain on the front burner. Staying focused on planning can help individuals find ways to improve their tax situation throughout the year.

Here are some tax planning considerations now that the filing season is over for most taxpayers.

Determine your marginal tax bracket

In the 1040 form for 2022, line 15 reflects taxable income. This figure defines an individual’s marginal tax bracket, which is useful for tax planning. Tax brackets and marginal rates for 2023 are reflected here. Knowing your marginal tax bracket for 2022 can aid in planning for this year by providing a sense of what income may look like for 2023. For those in lower tax brackets, strategies that increase income (e.g., Roth conversions) may make sense. Those in the highest tax brackets may want to consider strategies to reduce income. These actions could include contributions to health savings accounts or a pretax retirement account.

Did you claim the standard deduction this year?

Given the scale-back or elimination of many deductions, combined with the doubling of the standard deduction beginning in 2018, most taxpayers claim the standard deduction on their return. For those giving to charities, there may be tax-smart alternatives, such as lumping multiple years of charitable gifts into one year or using the qualified charitable distribution (QCD) strategy. See "Donating IRA assets to charity." Lumping several years of charitable gifts into one year may allow a taxpayer to itemize deductions for that return while claiming the standard deduction in subsequent years. Unless charitable gifts and other deductions (state and local taxes up to $10,000 annually, for example) exceed the standard deduction, it does not make sense to itemize deductions.

Review retirement plan contributions

Taxpayers may find they can increase retirement plan contributions and lower next year’s tax bill. Or, depending on the tax bracket, it may make sense to allocate a portion of salary deferrals to Roth accounts within an employer plan. Holding a mix of pretax and after-tax (e.g., Roth) savings can provide tax diversification in retirement. Having a choice of where to draw income in retirement may help hedge the risk of higher taxes in the future. For example, a taxpayer in the highest tax bracket in retirement needing more income may consider drawing tax-free income from a Roth account if available.

Make sure withholding is on target

Federal taxes are based on a “pay as you go” system. It’s important that taxpayers assign the appropriate withholding amount since the IRS can impose a penalty and interest if taxes paid via withholding or quarterly estimated payments are incorrect. Generally, most taxpayers will avoid this penalty if they either owe less than $1,000 in tax after subtracting their withholding and refundable credits. Or, if they paid withholding and estimated tax of at least 90% of the tax for the current year or 100% of the tax shown on the return for the prior year, whichever is smaller. Special rules may apply to certain types of taxpayers.

Taxpayers may also want to make sure they are not withholding a significant amount more than is required. If they do, they are essentially giving the government a no-interest loan for the year compared with having those funds to invest and work for them.

Seek expert advice

It is always optimal for taxpayers to meet with a financial professional with understanding of their personal financial situation. Seeking advice and reviewing tax planning throughout the year may help individuals take advantage of tax-efficient opportunities.