Mid-year is an excellent time to reassess your financial strategies and make sure you’re taking advantage of opportunities to reduce your tax liability. That begins with understanding the “ADCs” of reducing your tax burden:
- Avoid: Avoiding taxes is not the same as evading taxes. Tax avoidance involves reducing your overall tax liability through provisions in the tax law, including exclusions, tax credits, and deductions. Exclusions apply to income that isn’t required to be reported, such as tax-free interest earned on municipal bonds. Tax credits, like qualifying child care expenses, provide dollar-for-dollar reductions in tax liability. And deductions, such as alimony paid, reduce taxable income. Consult your tax advisor to determine the exclusions, credits, and deductions that apply to your specific situation.
- Defer: Deferring or postponing taxes on income to a future date when you anticipate your tax rate to be lower can be highly advantageous. While it doesn’t eliminate taxes owed, in certain cases it can help reduce your overall tax burden. If you contribute to a 401(k) or traditional IRA, you’re already familiar with this concept. Your current taxable income is reduced by the amount of qualifying contributions to your plan. Both contributions and earnings grow tax-free until you take distributions, usually upon retirement, when you may be in a lower income tax bracket.
- Convert: Seeking opportunities to convert ordinary income into long-term capital gains, which are taxed at a more favorable rate, is a common practice for lowering your overall tax liability. For example, short-term capital gains from the sale of stocks, collectibles, or artwork held for 12 months or less are treated as ordinary income and subject to the taxpayer's marginal tax rate. However, if you can hold the investment for more than 12 months before taking gains, the gains will be subject to more favorable long-term capital gains rates.
Before pursuing any strategy designed to reduce taxes, let’s meet together with your tax professional for guidance on the best approach for your financial situation. Call the office any time to schedule an appointment.
This communication is designed to provide accurate and authoritative information on the subjects covered. It is not, however, intended to provide specific legal, tax, or other professional advice. For specific professional assistance, the services of an appropriate professional should be sought.