Most people recognize that paying taxes is necessary. The money helps build and maintain highways and other infrastructure. It helps fight crime and keeps several important institutions operating. It helps defend the country.
But people also recognize this: No one wants to give Uncle Sam more money than necessary, especially since all of us have our own uses for that money.
That’s where good tax planning comes into play. With the right strategies, you can reduce your income tax bill, put fewer dollars in Uncle Sam’s pocket and keep more in yours.
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That can be especially beneficial for retirees, who need to make sure their money lasts the rest of their lives.
Let’s look at three ways you can give Uncle Sam less so you can keep more.
1. Carefully consider which assets to leave to beneficiaries.
It’s nice to be able to bequeath something to your children, grandchildren or others after you are gone. But as you make plans to do so, keep in mind the income tax ramifications, both for you and for your heirs. With the right moves, you both can avoid taxes.
For example, if you have assets such as stocks or real estate that have appreciated in value since you purchased them, you should consider the advantages of a “step-up in basis.” If you were to sell those assets now, you would pay capital gains taxes. on whatever gains you have made. Leave these assets to your heirs, though, and the situation changes because the step-up in basis rule comes into play. Under that rule, there is a restart on the date from which the gains are measured. Instead of being calculated from when you purchased the asset, the gain is determined from the time your heirs inherited the asset.
Let’s say that many years ago, you bought several shares of a stock for $10,000, and today those shares are worth $50,000. If you have the option, this might be a good candidate to leave to your heirs rather than sell right now. If you sold the stock, you would owe capital gains tax on the $40,000 gain. But if you leave the stock to your beneficiaries, their starting point for capital gains is $50,000 (or whatever the value is at the time of your death) because of the step-up in basis. If they sell quickly, they likely would owe little or no capital gains taxes.
2. Have a strategy to pay taxes efficiently.
But, of course, leaving assets to beneficiaries means someone else has to pay taxes after you are gone.
You are paying taxes in the here and now. As you do so, you need a strategy to make sure you are paying them in the most efficient manner and that you are taking advantage of anything in the tax code that allows you to pay less.
That begins with capitalizing on the income-tax deductions available to you. About 90% of taxpayers use the standard deduction, which has risen over the years, especially after the Tax Cuts and Jobs Act of 2017 was passed. The deduction is even higher for those who are blind or who are 65 and older, though you have to be sure to check a box on your 1040 form and add on the extra amount.
In the past, more people Itemized their deductions, and that is still an option. It’s just difficult for the average person to come up with enough deductions to bring the itemized total higher than the standard deduction. But if you can itemize and claim an even greater deduction than the standard, you want to go that route.
Among the tax deductions that could help you get to the appropriate total are mortgage interest, medical expenses and charitable contributions. Make sure you deduct only what is allowed, though. For example, medical expenses are deductible only when they exceed 7.5% of your adjusted gross income.
Another way to be efficient with your tax payments is to keep an eye on the income tax brackets and the possibility of dropping into a lower bracket. For example, if a married couple filing jointly can reduce their taxable income to $89,450 or lower, they move out of the 22% tax bracket and into the 12% bracket. (Extra deductions can help you move from one of the higher tax brackets as well, but the gap between the 22% bracket and the 12% is the largest.) It’s worth noting that even when you are in the higher bracket, all of your income is not taxed at the higher rate. Only the portion of your income that exceeds a certain threshold is taxed at that higher rate.
3. Make sure investments are in the proper accounts.
One other way to pay taxes efficiently is to make sure your investments are in the appropriate accounts that will be most likely to produce the desired results. If you aren’t careful, you can incur unnecessary taxes.
Essentially, the accounts you might have money invested in can be broken down into two types: accounts that are taxable and accounts that come with some sort of tax advantage.
Taxable accounts include brokerage accounts, where you might hold stocks. The upside with these is there is no age restriction or other restriction on getting access to your money. You do pay taxes, but if you have held the asset for more than a year, it is considered a long-term capital gain and is taxed at a lower rate than regular income.
Tax-advantaged accounts are those with investments that are tax-deferred, such as a traditional IRA or 401(k), or that are tax-exempt, such as a Roth IRA, where you pay the taxes now but not when you begin withdrawing money. Although these accounts give you some tax advantages, one tradeoff is they have rules on when you can withdraw money and penalties if you break those rules.
So where to put your money?
That comes down to the type of investment. As much as possible, you want investments that are subject to little or no taxes in your taxable accounts. Investments subject to a higher tax rate should go into the tax-advantaged account.
A good financial professional can help you determine the best investment accounts for your individual situation. That person can also help you find other ways to make sure you are paying taxes in the most efficient manner possible.
By taking the right measures, you will still pay what you legally owe — but not more than required.
Ronnie Blair contributed to this article.
The appearances in Kiplinger were obtained through a PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger.com. Kiplinger was not compensated in any way.
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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
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