With tax filing season behind us, many people won’t give taxes another thought until next spring. Financial experts warn this approach could cost you money and suggest year-round tax planning strategies that could boost your long-term wealth.
Here are six areas where taxpayers commonly make mistakes and key questions to consider throughout the year.
Many people fall into “same as last year” habits when it comes to tax decisions. However, tax results depend on constantly changing factors including earnings, market conditions, tax regulations, interest rates, and personal situations.
Consider these scenarios:
1. Home office deduction: The calculation method can vary. One approach is based on square footage, but allocating based on number of rooms might be better. The method chosen last year may not be optimal this year.
2. Vehicle expenses: The choice between standard mileage and actual expenses can change if driving patterns or vehicle costs change.
3. Standard versus itemized deduction: This should be calculated every year. Taxpayers can — and should — choose the better option annually. For example, a year with significant charitable giving, mortgage interest, or taxes paid may favor itemizing, while another year may not.
“Given my situation this year, what approach produces the best tax outcome for me?” is the key question to consider.
Once tax returns are filed, most opportunities for optimization have passed. Effective tax management requires ongoing attention throughout the year, not just annual preparation.
Important areas for continuous planning include:
4. Retirement contributions –Rothversus traditional: Choosing between a Roth 401(k) and a traditional 401(k) is fundamentally a tax decision: Should you pay taxes now (Roth), or defer taxes (traditional)? The right answer depends on both current and expected future tax rates.
5. Charitable-giving strategy: The tax benefit depends heavily on how you give. Donating appreciated securities instead of cash can eliminate capital gains tax. Bunching contributions into a single year can increase the likelihood of itemizing—at least every other year.
6. Bonus and supplemental income withholding: Bonuses are often withheld at flat rates that may not reflect actual tax liability. This can create either cash flow drag or underpayment risk.
7. Investment decisions: Realizing gains, harvesting losses, and holding periods all affect after-tax returns.
Ask yourself: “What decisions throughout the year will improve my after-tax outcome?”
Many people view tax refunds as a positive outcome. However, refunds simply indicate you overpaid throughout the year, essentially providing the government with an interest-free loan. Those funds could have been invested or used elsewhere during the year.
Consider: “Am I aligning my tax payments with my actual liability?”
Smart cash flow management is an essential component of effective tax planning.
Tax implications should influence decisions, not control them. While a deduction reduces expense costs, it doesn’t eliminate them entirely. Spending $1,000 to save $300 in taxes still results in a net outflow of $700.
This principle particularly applies to charitable contributions and investment decisions made for tax reasons rather than economic merit.
Ask: “Does this decision make sense on its own, before considering taxes?”
While tax software has become more user-friendly, it hasn’t eliminated the need for professional expertise.
Complex situations for taxpayers often involve:
8. Capital gains and losses coordination
9. Multi-account asset location
10. Timing decisions across tax years
11. Interactions between income, deductions, and credits
Mistakes or missed opportunities can be subtle but expensive over time.
Consider: “What is the long-term cost of suboptimal tax decisions?”
Some of the most valuable tax strategies begin with simple questions, many of which initially seem unlikely.
For example, can I deduct my pet expenses? Usually no. But in specific cases, such as a legitimate service animal, these expenses may qualify as medical deductions.
The key is not whether a question leads to a “yes,” but whether it uncovers possibilities or clarifies boundaries.
Ask: “Is there any situation where this could apply to me?”
Effective tax planning isn’t about pursuing every possible deduction or reducing a single year’s tax bill. The goal is maximizing after-tax wealth over the long term.
The most valuable approaches:
12. Challenge assumptions
13. Focus on strategy, not just transactions
14. Integrate taxes into broader financial decisions
Shifting from “What can I write off?” to “How should I plan?” can significantly improve long-term financial outcomes. This strategic approach is where thoughtful tax planning delivers its greatest value.
This article was provided to The Associated Press by Morningstar.
Sheryl Rowling, CPA, is an editorial director, financial adviser for Morningstar.
