Reactive VS Proactive Tax-Planning

| May 17, 2018

During the tax preparation process, clients often ask us what they can do to lower their tax bill. Unfortunately, as many of you have heard, “April is too late for tax planning.” While we work diligently with clients to make sure we do not leave deductions on the table for actions they have already taken during the past year, there is little one can do in the current year to affect a prior year’s tax bill. If you have earned income, the easiest thing to do, if eligible, is to contribute to your IRA. If you do not make a contribution during the year, fear not, the rules allow for making a “prior year” contribution by the original due date of your tax return, April 15th in most cases. Total contributions for any given year are 100% of earned income up to $5,500 with an additional $1,000 catch-up contribution for those age 50 or older.

With that said, April does not have to be too late for tax planning…IF we are talking about being proactive THIS year. Here are a couple of options. Maximize contributions to your employer retirement plan; if you cannot maximize the plan, at least contribute enough to take advantage of any employer provided match. This is free money, but contributions are made through payroll deduction so the sooner you start, the more you can take advantage of this benefit.

But what if you are self-employed or own a small business? Two of the most effective options are to establish a SEP IRA or a Solo 401(k) plan. There are numerous factors to consider, so a conversation with your advisor is warranted. With a Solo 401(k) plan, the plan must be established by December 31st. Contributions can include up to $18,500 for employee deferral ($6,000 catchup contributions also allowed for age 50 and older) plus an additional 25% (20% for self-employed) profit sharing contributions for a total allowable contribution of up to $55,000. A SEP IRA can be established and funded by the due date of the return plus extensions. Contributions to a SEP are limited to the lesser of $55,000 or 25% of eligible employees’ compensation.

Few things illustrate the value difference between proactive tax-planning and reactive tax-preparation than the sizeable benefits resulting from involved planning. Not only can many people make important reductions in their tax bills, thus freeing up money for other purposes, but tax-planning allows people to provide for a more secure and fulfilling retirement in the future.