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Talking Taxes

Historically, many people don’t think about taxes until they’re facing the April 15 deadline. But it’s always beneficial to think about tax planning all year long. 

One of the best ways to save on income taxes is to max out your 401(k) contributions. You can contribute up to $19,500 into your 401(k) in 2020 and if you are age 50 or over, you can make an additional “catch-up” contribution of $6,500. But this is just the beginning. Throughout the year, you should also review with your financial planner the “nuts-and-bolts” things that can impact taxes: estimated tax payments, the sale of a residence, distributions from qualified plans or IRAs, as examples.

In addition, reviewing your estate plan with your financial advisor throughout the year may help reveal some additional tax-reduction strategies appropriate to your situation.

The “Stealth” tax

Under the so-called “stealth” tax, you lose parts of certain deductions—medical expenses; interest on second mortgages; state and local taxes; and charitable gifts, among them—once your adjusted gross income reaches a certain level or you use the standard deduction if higher.

Since the tax legislation that was passed in 2017, the alternative minimum tax (AMT) affects significantly fewer taxpayers. However, if you’re still subject to the AMT, one of the things you can do that may help reduce or avoid the AMT is to exercise your employee stock options wisely. There are two types of employee stock options: incentive stock options (ISOs) and nonqualified stock options, with the tax implication being the biggest difference between them. While nonqualified stock options are taxed as ordinary income when they are exercised (then if you exercise and hold the stock for more than a year, you can pay long-term capital gains tax on the additional appreciation), ISOs may be subject to the AMT when they’re exercised.

Currently, the highest federal income tax rate is 37%; the highest AMT is 28%. In tax preparation, your income is run through both calculations and you pay whichever one is higher. (For example, if your regular federal tax is $90,000 and the AMT is $100,000, you pay $90,000 regular federal tax and $10,000 for AMT.) To be strategic about taxes, try to balance your ordinary federal income tax with your AMT tax amount. If you can increase your ordinary income on one side, say by exercising nonqualified stock options, it may leave room to exercise ISOs on the AMT side without incurring the AMT, if your tax situation permits.

Gifting strategies

One thing that could help save taxes is to shift passive income-producing assets like rental real estate to a family limited liability corporation (LLC) or a family limited partnership (FLP). You can achieve this by gifting fractional interests to family members who may be in lower income tax brackets.

Gifting can also be a sound tax-savings strategy. Instead of giving cash to a charity, consider gifting appreciated capital assets. You don’t have to pay any tax on the gain—and neither does the charity. Depending on the capital asset and your tax situation, you may get the deduction for the fair market value of the gift subject to certain limitations, which would also eliminate the capital gains tax.

College savings plans

The popular 529 college savings plans have emerged as a terrific college-funding planning and tax savings tool for families who can front-load up to five years’ worth of contributions per child. Under a special election, a 529 account owner can choose to front-load up to $75,000 per beneficiary, or $150,000 for married couples, into the college savings plan without generating a taxable gift—assuming no other gifts are made to the beneficiary over the five-year timeline.

Speak with a financial professional

Taxes aren’t something to be discussed only on an annual basis. Your finances, and tax legislation, can change at any time. Even if you already know a lot about taxes, saving, and investing, seeking regular guidance from a financial professional can add to your knowledge, answer your tough questions, and provide another perspective.