Tax Planning Transactions
Tax planning is not to be confused with tax evasion. Tax evasion is an illegal attempt to avoid paying the correct amount of taxes you owe, usually by hiding income or falsifying tax records. Tax planning, on the other hand, is an attempt to pay the minimum amount of tax that you legally owe. Successful tax planning involves undertaking any of a series of legal actions that can help you avoid paying excessive tax.
Gains and Losses
One of the great benefits of having a loss on your investments is that you can use it to lower your taxes. If you have taxable capital gains, such as profits on stock trades, the Internal Revenue Service allows you to offset those gains with losses. The ability to offset gains and losses is unlimited. For example, if you have $100,000 in both gains and losses, you won't have to pay tax on any of your gains. If your losses exceed your gains, you can take up to $3,000 of losses to offset ordinary income and carry forward any remaining losses for use in future years. However, you must realize your losses to use them for tax purposes. A realized loss is one you have actually taken by selling your investment. A loss on paper only doesn't count for tax purposes.
Deferring or Advancing Income
If you can defer or "push" your income into the next tax year, you can delay paying tax on it. Generally, the longer you can wait to pay your tax the better. If you plan on taking money out of an individual retirement arrangement, or if you are due a year-end bonus, you may be able to delay receiving that money until January, thereby deferring the tax until the next year. Income manipulation can work both ways. If you anticipate that you'll be in a higher tax bracket next year, you might want to advance any income you can into the current year, so you'll be taxed at a lower rate.
The IRS offers numerous tax breaks you can use to lower your taxes. Making an IRA contribution may allow you to deduct as much as $5,500 off your income, or even $6,500 if you're 50 or over, as of 2013. If your employer offers a 401(k) plan, the amounts jump to $17,500 and $23,000, respectively. Itemizing deductions on your taxes will allow you to use your charitable contributions, mortgage interest payments and other deductible expenses to lower your taxes.
Not all investments are taxed the same way. Long-term gains, for example, are taxed at a maximum of 23.8 percent as of 2013, while short-term gains, which are taxed the same as ordinary income, can be taxed as high as 39.6 percent. The IRS designates investments held for longer than one year as long-term, so holding on to your investments for a longer time can end up helping lower your taxes. The type of income you receive from your investments can also affect your tax planning. While most interest payments, such as those from bonds and savings accounts, are taxed as ordinary income, dividends from stocks can be taxed at just 20 percent as of 2013, even for higher-income taxpayers.
John Csiszar has written thousands of articles on financial services based on his extensive experience in the industry. Csiszar earned a Certified Financial Planner designation and served for 18 years as an investment counselor before becoming a writing and editing contractor for various private clients. In addition to his online work, he has published five educational books for young adults.