If you want to make a tax planner unhappy, wait until the last minute to start thinking about your taxes.
Nearly one-third of Americans put off doing their taxes until just before the deadline, according to IPX1031’s 2024 Tax Procrastinators report. The most common reason is that procrastinators assume they aren’t going to get a refund, so there isn’t any reason to hurry.
The elephant in the room is, they don’t know how big the elephant in the room is! If you think you’re not getting a refund, it’s likely you think you will owe money to the government, but without running the numbers, you have no idea how much that will be. The sooner you know that amount, the easier it is to make sure you have enough to pay it by Tax Day.
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That’s only the most readily apparent problem with putting off taxes. The greater issue is that tax procrastinators can cost themselves significant sums of money: Unless you plan for taxes throughout the year, you can miss opportunities to lower your tax burden. A good way to think about tax season is as if you were a historian.
Your options are more limited the longer you wait
The first quarter of the year is when you look back at what happened during the previous year so you can fill out the appropriate forms and file your taxes. Your options for decisions regarding those taxes are extremely limited. Realistically, only one choice remains for most people: whether you should contribute to an IRA for the previous tax year. Almost every other tax-related choice needs to be made within the tax year; after December 31, those choices vanish.
This is why the timeframe beginning immediately after you file last year’s taxes is the perfect time to start planning for next year’s. Planning far enough in advance helps you avoid surprises.
Determine your expected income for the coming year, as well as how much you intend to save. Consider which of your assets you might wish to move from taxable accounts to tax-free accounts — for example, rolling a traditional IRA into a Roth IRA. This question goes deeper than how much of your retirement savings you want tax-free in retirement. You should also consider your tax burden now; those Roth conversions are taxable. Are you trying to stay under a certain tax bracket?
Is there unused room in your tax bracket?
Some might look at their return and determine they’re going to be in a specific tax bracket no matter what, but there might be unused room within that bracket. If you determine you will finish the year in the 22% bracket with $5,000 to go before you hit the 24% bracket, you have options. You could consider filling some of that headroom with a Roth conversion.
This consideration becomes particularly important when you realize that the current tax environment is unlikely to continue. When the Tax Cuts and Jobs Act expires at the end of 2025, so too will the current tax brackets, which will revert to their previous levels. Unless Congress renews the TCJA — a scenario most feel is unlikely — the 22% bracket will become a 25% bracket. This will make strategic tax moves such as Roth conversions more expensive. In other words, if you think a Roth conversion is right for you, there’s likely no time like the present.
Year-round tax planning should also consider other factors. Do you anticipate a major event this year, such as selling a home or investment property? That could have a significant tax consequence, meaning it’s wise to consider strategies to minimize or offset those taxes. Charitable donations and other opportunities for tax write-offs can help lessen the blow of the tax burden you will face when receiving large amounts of income.
However, those charitable donations won’t impact your taxes if they don’t rise to a higher level than the standard deduction. Tax planning can help solve this problem as well; if you know you won’t donate enough this year to eclipse the standard deduction, but over the next few years your donations would rise above that number, you can make several years’ worth of donations this year instead of doling them out each year.
This doesn’t mean you can’t give anything in non-donation years; vehicles such as a donor-advised fund allow you to donate a large chunk of money now to the fund to enjoy the tax deduction, then direct how that money gets disbursed over the coming years to further your charitable giving.
Another tax reduction strategy: QCDs
The qualified charitable distribution (QCD) is another tax reduction strategy, available to those over age 70½, in which you can donate directly from your tax-deferred retirement accounts. This accomplishes three things: The charitable organization gets a donation, the withdrawal from your account is tax-free unlike regular withdrawals, and the donation counts toward your required minimum distribution (RMD).
It’s important to note that your order of operations matters here: QCDs should be taken out before any other withdrawals are made to satisfy the RMD. Otherwise, the QCD may not satisfy the RMD and could be subject to taxation.
In short, your goal in tax planning throughout the year is to never be surprised at tax time. As you move deeper into tax planning, you’ll quickly discover it can be quite complicated! It’s important to seek guidance from a financial planner to maximize your tax efficiency as you change your habits from last-minute taxes to year-round.
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