Taxes are necessary and almost inevitable. However, like most expenses, such as food or mortgage, planning allows you to save more of your hard-earned money. Here is where tax planning strategies come in.
What makes tax planning strategies challenging at first is that it depends on a handful of factors. Aside from the income that is subject to change, aspects of the tax code might be difficult to follow for ordinary taxpayers.
If you’re looking to manage your finances more effectively, here are five tax tips and planning strategies you might not know about:
1. Utilize tax savings from QSBS
Devised initially to encourage support for small businesses and startups, Section 1202 of the Internal Revenue Code (IRC) has become one of the most beneficial tax strategies available. The IRC section defines qualified small businesses (QSB) and the qualified stocks that come from them. Upon meeting specific requirements, such as being the first or direct buyer and holding the QSBS for five years, the investor qualifies for generous tax breaks.
Although the tax break still depends on when the QSB stock was acquired, those received between 2010 and 2014 are qualified for a 100 percent tax deduction. QSBS exempts all capital gains made from selling these stocks, which is limited to $10 million or ten times the initial investment, whichever is greater. It doesn’t end there, though, as you can virtually enjoy unlimited tax breaks by stacking your qualified small business tax through a variety of additional strategies.
2. Maximize HSA contributions
Most people are not aware that the funds they have put into their Health Savings Account (HSA) do not expire or become forfeit, even when they don’t use it regularly. You can keep paying your HSA fund, let it accumulate, or reinvest it for your retirement funds.
Generally, your HSA offers four main benefits that will significantly help your next tax planning session:
- You can put in pretax or tax-deductible income. You are already looking at tax savings on otherwise taxable income by paying on a pretax or tax-deductible basis.
- Your accumulated funds continue to grow as a passive, tax-free investment.
- You can withdraw funds to cover your qualified medical expenses, which are also tax-free.
The fourth benefit is something a lot of people don’t know. Pretax contributions made to your HSA fund are also exempted from Medicare and Social Security taxes, collectively known as the Federal Insurance Contributions Act. All these benefits protect your income from taxes, let you set up a growing retirement fund, and give you an emergency fund for qualified medical emergencies.
3. Set up a charitable remainder unitrust
Also known as a CRUT, charitable remainder unit trust funds are tax planning tools designed to continuously provide income to an identified beneficiary such as your spouse or children for a set period or a lifetime. After the specified period, whatever remains in the fund is given to a charitable organization of your choice.
While there are different types of CRUTs, such as a standard unitrust or a flip CRUT, they all share the same basic setup and the favorable tax treatments–although the latter might vary depending on the type.
Assets placed within the CRUT are exempted from capital gains tax when sold, allowing you to build wealth with the otherwise taxable income. This benefit also makes CRUTs a highly-favorable tax planning method for transferring appreciating stock like artworks and NFTs into trust funds. Not only that, but you can even name yourself as a beneficiary and receive income from the funds.
4. Make the most out of your 401(k) contributions
The IRS has recently increased the contribution limits for 401(k) retirement plans, now up to $20,500. Still, the catch-up contribution–or the additional contribution for people 50 and above–remains $6,500. The new limits create an opportunity for you to increase your regular contributions. If it’s not possible, you can change your contribution rate for the incoming taxable year from 1 to 2 percent.
By doing so, you add up to your contribution while reducing your taxable income. Traditional 401(k) contributions are deducted from your salary before any income taxes factor in. It can even change your tax bracket, qualifying you for more tax breaks in some cases. Additionally, the IRS waives all taxes for contributions up until your retirement.
5. Maintain a tax payment plan
Tax payment plans are essential strategies to avoid fines and qualify for tax credits and tax breaks whenever applicable. These plans are beneficial for small business owners, independent contractors, and other members of the bustling gig economy who usually pay estimated taxes. By maintaining a rigid payment plan, you can ensure that you consistently surpass 90 percent of your estimated liability or at least a full hundred percent for your tax liabilities the previous year. Lastly, a tax payment plan saves you from underpayment penalties.
The Internal Revenue Service defines the following periods and due dates for 2022:
- January 1 to March 31, 2022, are due on April 18, 2022
- April 1 to May 31, 2022, are due on June 15, 2022
- June 1 to August 31, 2022, are due on September 15, 2022
- September 1 to December 31, 2022, are due on January 17, 2023.
Additionally, if you plan to file your 2022 tax return on January 31, 2023, and settle your remaining balance for the fourth quarter, you may opt not to pay the January 17 schedule.
Tax planning strategies are there to ensure you don’t miss out on opportunities to save more from your money and avoid hefty fines. By thinking ahead, you can plan not only your taxes but the rest of your finances accordingly.