What happens to your tax liability if you plan your finances properly? (2023)

What happens to your tax liability if you plan your finances properly? (1)

Taxes are inevitable, but that doesn't mean you have to pay more than you owe. What happens to your tax liability if you plan your finances properly? The simple answer is that it allows you to reduce your debt while keeping more of your income to fund your financial goals.A conversation with a financial advisoris a good first step in developing a strategy for effective tax liability management.

understand the tax liability

A tax liability refers to money owed by an individual, business, or organization to a federal, state, or local taxing authority. A simpler way to think about your tax liability is the difference between yourtaxable incomeand tax benefits you can claim.

As a general rule, higher income can result in higher tax liability. The US uses a tiered tax system, which means that income and tax rates converge. As your income increases, so does your tax rate.

(Video) How to estimate your personal income taxes

However, the amount you pay in tax depends on your incomecapital gainit can also affect your tax liability. This is important to know if you are focused on investing and building wealth, as higher net worth individuals may face a higher tax liability if they make capital gains from investments.

What happens to your tax liability if you plan your finances properly?

Managing your tax liability is important because it can have a direct impact on how much of your income or capital gains you are allowed to keep. The more income and wealth you have, the easier it is to build wealth.

Proper financial planning can help you implement strategies aimed at minimizing taxes while maximizing your incomefinancial assets. With a solid financial plan, you can achieve significant tax savings year after year. You can then use those savings to generate additional income through investments, grow your retirement account, and increase your net worth.

Does financial planning require working with a financial advisor? Not necessary. You could always do it yourself. However, there are some key benefits to having a financial advisor help you create a tax liability management plan.

Financial advisors have extensive knowledge of how tax planning can affect your financial planning. A good advisor is also familiar with the tax law and the latest tax rules. Even if you think your tax situation is relatively straightforward, a financial advisor can identify areas for tax efficiency improvement that you may have overlooked.

(Video) How to Calculate Your Federal Income Tax Liability | Personal Finance Series

Financial planning strategies to reduce tax liability

What happens to your tax liability if you plan your finances properly? (2)

Depending on the specifics of your situation, there are various tax planning options to reduce your tax burden. When you work with a financial advisor to create a tax plan, it may include some or all of the following.

retirement planning

Retirement planning is a key focus of sound financial planning, especially when it comes to taxes. As well as making sure you have enough money for retirement, it's also important to consider how much of your savings you can keep after you start withdrawing.

As you plan for retirement, your financial advisor may suggest the following:

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  • Maximize annual contributions for aTraditional 401(k)or to a Roth 401(k) if you have that option.
  • Contribute money to a traditional or Roth IRA each year.
  • Health Savings Account (HSA) funding if you have the option with a high-deductible health plan.

If you are self-employed or own a business, you can open a Solo 401(k) account.SEP IRAor a SIMPLE IRA to save for retirement instead. It is important to understand the tax treatment of different retirement options.

For example, traditional 401(k) plans and traditional IRAs allow tax-deductible contributions. Qualified distributions are taxed as ordinary income after retirement. Roth accounts don't offer tax benefits, but you can make tax-free withdrawals after retirement.

Ahealth savings bookit is not a retirement account per se. It's designed to save money for medical expenses, but it can also serve as a source of retirement income because you can withdraw money for any purpose after age 65 without any tax penalties. You only pay regular income tax on the withdrawals.

investment planning

Investment planning is related to retirement planning, but can involve different aspects of managing tax liabilities. Let's say you invest through a taxable brokerage account that is subject to capital gains tax. Your financial advisor can offer a number of strategies for managing tax liabilities, including:

  • Stopinvestmentslonger than one year in order to take advantage of a more favorable long-term capital gains tax rate.
  • Choosing tax-efficient investments such as exchange-traded funds (ETFs) that can cause fewer turnover events than traditional mutual funds.
  • bear tax lossesto offset some or all of your capital gains for the year.

Your advisor can also help you deduct expenses associated with investing in real estate if you own one or more rental homes. They can also help you complete a 1031 exchange if you are interested in exchanging one property for another to reduce capital gains taxes.

(Video) How to Manage Cash Reserves in Retirement

Tax credits and reliefs

Tax deductions reduce your taxable income, which can help you move into a lower tax bracket for the year. There are a number of expenses you may be able to deduct, including:

  • mortgage rates
  • State and local taxes
  • Charitable donations
  • business expenses
  • self-employment costs
  • Treatment costs
  • Interest on student loans

Tax credits, on the other hand, reduce your tax liability on a dollar-for-dollar basis. For example, if you owe $1,000 in taxes and qualify for a $1,000 tax credit, the credit can cancel out your debt. Some credits are refundable, which can increase the amount of your tax refund for the year. A financial advisor can guide you through the various deductions and credits you can claim to reduce your tax liability.

Payment planning

As you approach retirement, it's important to think about how to withdraw the money you've saved. Your counselor can discuss thisstrategiesto withdraw money from a 401(k), IRA ortaxable brokerage accountSo you don't pay too much tax or use up your retirement savings too quickly.

Your advisor can also discuss tax-advantaged ways to generate additional income in retirement, such as buying an annuity or taking out a reverse mortgage. A counselor can also help you decide when to take itSocial security benefitshow to maximize your payout and how to balance those pensions with other sources of income.


What happens to your tax liability if you plan your finances properly? (3)

(Video) Robert's Journey: The 7 Retirement Mistakes You Must Avoid (💬Stories) The Investing Iguana

In order to develop a long-term strategy, it is important to know what will happen to your tax liability, and with proper financial planninggrowing wealth. Giving more money in taxes than necessary does not provide any tangible benefit and can be problematic if it leaves less money for saving and investing. And... to havea reliable financial advisorBy working with you, we can ensure that you meet your tax obligations without missing out on your goals.

Tips for financial planning

  • Tax planning can seem complicated if you are not familiar with the Internal Revenue Code. Finding a financial advisor doesn't have to be difficult.Besplatni alat SmartAssetaputs you in touch with up to three trusted financial advisors based in your area, and you can have a free introductory chat with your real advisors to decide which one is right for you. When you're ready, find an advisor who can help you achieve your financial goals,Start now.
  • Robo-advisors can offer a more cost-effective way to manage financial planning, as fees can be lower than fees for traditional advisors. However, it is important to know what you are getting for your money. For example, some robo-advisors offer tax loss carrybacks, but not all. Additionally, robo-advisors are not actually able to provide personal tax planning or investment advice. These are good reasons to think about itCooperation with a human advisorinstead, even if it means paying a slightly higher fee.

Credits: ©iStock.com/Wasan Tita, ©iStock.com/Extreme Media, ©iStock.com/Charday Penn

Rebecca Lake, CEPF®Rebecca Lake is a retirement, investment and estate planning expert who has been writing about personal finance for a decade. Her financial niche expertise also extends to home buying, credit cards, banking and small businesses. She has worked directly with several major financial and insurance brands, including Citibank, Discover and AIG, and her writing has been published online in the U.S. News and World Report, CreditCards.com and Investopedia. Rebecca graduated from the University of South Carolina and also attended Charleston Southern University as an undergraduate. Originally from central Virginia, she now lives on the North Carolina coast with her two children.


What happens to your tax liability if you plan your finances properly? ›

What happens to your tax liability with proper financial planning? The simple answer is that it can allow you to minimize what you owe while preserving more of your income to fund your financial goals. Talking to a financial advisor is a good first step in creating a strategy for effectively managing tax liability.

Can I lower my tax liability? ›

So to answer the question, there are ways you can minimize your tax liability, including increasing retirement contributions, taking part in employer-sponsored plans, profiting from losses, and donating to charities.

How might taxes have an impact on a person's financial plan? ›

How might taxes have an impact on your financial plan? Taxes control how much of your income you keep.

Do financial planners know about taxes? ›

Taxes are a central component of financial planning. Almost every financial planning issue – whether it is retirement, investments, cash flow, insurance, or estate planning – has tax considerations, and advisors provide a great deal of value in helping clients minimize their overall tax burden.

What is the purpose of tax planning? ›

Tax planning is a focal part of financial planning. It ensures savings on taxes while simultaneously conforming to the legal obligations and requirements of the Income Tax Act, 1961. The primary concept of tax planning is to save money and mitigate one's tax burden.

How do I avoid federal income tax liability? ›

To be exempt from withholding, both of the following must be true:
  1. You owed no federal income tax in the prior tax year, and.
  2. You expect to owe no federal income tax in the current tax year.

How do I change my tax liability? ›

Filing an amended tax return
  1. Use a Form 1040-X, Amended U.S. Individual Income Tax Return.
  2. Attach/include copies of all forms and schedules that you're changing.
  3. If filing by paper, mail all documents using the “Where to File” information in the IRS Form 1040-X Instructions.
Feb 8, 2022

Who benefits from tax planning? ›

Thoughtful tax planning is vital for any wealth-management strategy. It can help you save for your child's education or a retirement fund, grow your small business, maximize your income and protect you from legal penalties, among other advantages.

What are the 3 basic tax planning strategies? ›

There are a number of ways you can go about tax planning, but it primarily involves three basic methods: reducing your overall income, increasing your number of tax deductions throughout the year, and taking advantage of certain tax credits.

What are 3 main factors that impact the amount of taxes we pay? ›

Here are six of the biggest factors in calculating income tax:
  • Taxable Income. The federal tax system is progressive, meaning that generally your tax rate increases as your income increases. ...
  • Filing Status. Besides income, the taxes you pay depend on your filing status. ...
  • Adjustments. ...
  • Exemptions. ...
  • Tax Deductions. ...
  • Tax Credits.
Sep 16, 2022

Why not to use a financial planner? ›

Simply put, they don't offer good value or ROI compared to what they cost. If you really want to unlock financial freedom, doing it yourself is the way to go. And now that you know it's not only possible – but easy – you can get started.

What are the disadvantages of financial planner? ›

Cons of Being a Financial Advisor
  • Building an advisor practice and growing a client base may be challenging.
  • Completing the necessary requirements to get certified and licensed can be time-consuming and costly.
  • Working hours are often long, particularly in the early stages of growing an advisor business.
Mar 23, 2023

Should my financial advisor also do my taxes? ›

Typically, financial advisors work with their clients on specific tax issues, but they can also engage in tax preparation services. Financial advisors sit down with their clients and work with them to maximize their tax returns and cash flow.

What is tax planning strategy? ›

A tax planning strategy is an action that a business or an individual can take to lower their tax burden. There are many different types of tax strategies.

What is the difference between tax avoidance and tax evasion? ›

Tax evasion means concealing income or information from tax authorities — and it's illegal. Tax avoidance means legally reducing your taxable income. Tina Orem is an editor at NerdWallet.

What is the goal of tax planning is tax minimization? ›

A major goal of tax planning is minimizing federal income tax liability. What is Investment Tax Planning? Investment tax planning involves evaluating how to best position assets in order to minimize the amount of taxes you have to pay on an ongoing basis.

How do I know if my tax liability is zero? ›

Now, if your total tax (line 24) minus your total payments (line 33) equals zero, congratulations! You owe nothing and get nothing back. You covered your tax liability throughout the year.

How is tax liability determined? ›

Your taxable income minus your tax deductions equals your gross tax liability. Gross tax liability minus any tax credits you're eligible for equals your total income tax liability.

What determines federal income tax liability? ›

Tax liability is determined by subtracting any credits or deductions from the taxpayer's total taxable income. Taxpayers can reduce their tax liability by taking advantage of deductions, credits, and other available tax breaks. Taxpayers with a higher income may be subject to higher tax brackets and owe more in taxes.

Can you have a tax liability and still get a refund? ›

If your refund exceeds your total balance due on all outstanding tax liabilities including accruals, you'll receive a refund of the excess unless you owe certain other past-due amounts, such as state income tax, child support, a student loan, or other federal nontax obligations which are offset against any refund.

How can I reduce my tax liability at the end of the year? ›

To lower your tax bill, you can accelerate deductions by paying deductible expenses or making contributions to tax-deferred retirement accounts or charities by the end of the tax year.

How to reduce tax liabilities 2023? ›

Take Action Now to Reduce Your 2023 Tax Liability
  1. Income tax brackets for 2023. ...
  2. How to get into a lower tax bracket and pay a lower rate. ...
  3. Max out your retirement contributions. ...
  4. Contribute to a Health Savings Account (HSA) ...
  5. Consider a Qualified Charitable Distribution (QCD) ...
  6. Summary.

Who benefits the most from taxes? ›

Lower Income Households Receive More Benefits as a Share of Total Income. Overall, higher-income households enjoy greater benefits, in dollar terms, from the major income and payroll tax expenditures.

Who benefits the most from progressive tax? ›

Advantages of a Progressive Tax

On the pro side, a progressive tax system reduces the tax burden on the people who can least afford to pay. That leaves more money in the pockets of low-wage earners, who are likely to spend more of it on essential goods and stimulate the economy in the process.

Which tax rate is most important for tax planning? ›

Planning at the margin – Marginal tax rates are what we tend to focus most on in tax planning, since that is where the real permanent tax savings can be derived. Most people don't really understand the concept of marginal tax rate. The general thought is that the higher your income the higher your marginal rate.

How much should I pay for tax planning? ›

Hourly rate: Tax planning financial advisors may charge $100 to $400 an hour, depending on their level of professional certification and experience and the complexity of the client's situation, for giving tax advice.

What is a tax loophole? ›

A tax loophole is a tax law provision or a shortcoming of legislation that allows individuals and companies to lower tax liability. Loopholes are legal and allow income or assets to be moved with the purpose of avoiding taxes.

How can high income earners reduce taxes? ›

Here are some of the best ways to reduce taxes for high-income earners.
  1. Fully Fund Tax-Advantaged Accounts. ...
  2. Consider a Roth Conversion. ...
  3. Add Money to a 529 Account. ...
  4. Donate More to Charity. ...
  5. Review and Adjust Your Asset Allocation. ...
  6. Consider Alternative Investments. ...
  7. Maximize Other Deductions.
Apr 21, 2023

Who pays the most taxes in the US? ›

The highest-earning Americans pay the most in combined federal, state and local taxes, the Tax Foundation noted. As a group, the top quintile — those earning $130,001 or more annually — paid $3.23 trillion in taxes, compared with $142 billion for the bottom quintile, or those earning less than $25,000.

What percentage of Americans actually pay taxes? ›

In total, about 59.9 percent of U.S. households paid income tax in 2022.

What can decrease how much income tax you have to pay? ›

Contributing to qualified retirement and employee benefit accounts with pretax dollars can exempt some income from taxation and defer income taxes on other earnings. Tax rates on long-term capital gains are low. Capital loss deductions can reduce taxes further.

What are the common mistakes in financial planning? ›

10 common financial planning mistakes
  • Failing to make a financial plan. ...
  • Not communicating. ...
  • No or little emergency fund. ...
  • Insufficient protection. ...
  • Not saving enough. ...
  • Not reviewing their financial plan regularly. ...
  • Picking a retirement date out of 'thin air' ...
  • Not updating Wills and beneficiaries.

Is it better to have a financial advisor or financial planner? ›

For example, if you have short-term issues or need assistance with specific questions or investments, a financial advisor can usually be a big help. However, if you want support for developing a comprehensive long-term plan for your finances, you may be better off working with a financial planner.

Is it better to have a financial advisor or do it myself? ›

Depending on your investing expertise, you may see better investment results working with an advisor than by managing money yourself. Your advisor can keep you from making expensive, emotional decisions. Emotion can be an investor's worst enemy.

Do financial planners get sued? ›

The Most Common Reasons That Stockbrokers and Financial Advisors Are Sued. Stockbrokers and financial advisors fail to live up to their professional duties in a variety of ways. In some cases, investor lawsuits and arbitration claims involve allegations of outright theft or forgery of documents.

Do financial planners beat the market? ›

Decades of data show that individual advisors, even the highest paid, do not consistently beat the market indexes. Plus their advice is expensive, which reduces your investable assets each year, resulting in lower long-term returns.

What is the failure rate of financial planners? ›

What Percentage of Financial Advisors are Successful? 80-90% of financial advisors fail and close their firm within the first three years of business. This means only 10-20% of financial advisors are ultimately successful.

Is it okay not to have a financial advisor? ›

Perhaps this myth has persisted for so long thanks to persistent marketing on behalf of financial advisory firms. However, the reality is that investors who manage their own money are often able to perform better than those who work with a financial advisor and without fees eating into their returns.

Who is the best financial advisor? ›

The Best Financial Advisors of 2022
  • Best Overall: Fidelity Investments. ...
  • Best for Mixing Robo-Advice with a Human Touch: Vanguard Personal Advisor Services. ...
  • Best for Commission-Free Advisors: Zoe Financial. ...
  • Best for Low-Cost Unlimited Access to Advisors: Betterment.

What is the difference between a CPA and a financial advisor? ›

However, in the context of CPA vs financial advisor, the significant difference between the two is that while the former handles your taxation and auditing needs, the latter caters to your investment needs. Both these professionals are sought-after in the business world for providing a wide range of financial services.

Is it better to claim 1 or 0 on your taxes? ›

By placing a “0” on line 5, you are indicating that you want the most amount of tax taken out of your pay each pay period. If you wish to claim 1 for yourself instead, then less tax is taken out of your pay each pay period.

How can high income earners reduce tax liability? ›

Later in this post, we will review potential changes that may affect high earners.
  1. 2023 Federal Income Tax Brackets. ...
  2. Max Out Your Retirement Contributions. ...
  3. Roth IRA Conversions. ...
  4. Buy Municipal Bonds. ...
  5. Sell Inherited Real Estate. ...
  6. Set Up a Donor-Advised Fund. ...
  7. Use a Health Savings Account. ...
  8. Invest in Companies that Pay Dividends.
Jan 30, 2023

How can an LLC reduce tax liability? ›

As an LLC owner you're able to reduce taxes by:

Claiming business tax deductions. Using self directed retirement accounts. Deducting health insurance premiums. Reducing taxable income with your LLC's losses.

Why do I owe taxes every year when I claim 0? ›

There are a few reasons why you would still owe money if you have claimed zero on your tax forms. Some reasons are if you have additional income, have a spouse that earns income or if you earn bonuses or commissions.

Do you get taxed more if you claim 0? ›

Claiming 1 on your tax return reduces withholdings with each paycheck, which means you make more money on a week-to-week basis. When you claim 0 allowances, the IRS withholds more money each paycheck but you get a larger tax return.

Is claiming 2 better than 0 on taxes? ›

You can claim anywhere between 0 and 3 allowances on the W4 IRS form, depending on what you're eligible for. Generally, the more allowances you claim, the less tax will be withheld from each paycheck. The fewer allowances claimed, the larger withholding amount, which may result in a refund.

How long does a tax liability last? ›

In general, the Internal Revenue Service (IRS) has 10 years to collect unpaid tax debt. After that, the debt is wiped clean from its books and the IRS writes it off. This is called the 10 Year Statute of Limitations.

How much should I put in my 401k to lower my tax bracket? ›

Since 401(k) contributions are pre-tax, the more money you put into your 401(k), the more you can reduce your taxable income. By increasing your contributions by just one percent, you can reduce your overall taxable income, all while building your retirement savings even more.

How do I get a bigger tax break? ›

6 Ways to Get a Bigger Tax Refund
  1. Try itemizing your deductions.
  2. Double check your filing status.
  3. Make a retirement contribution.
  4. Claim tax credits.
  5. Contribute to your health savings account.
  6. Work with a tax professional.
Mar 22, 2023

What are three factors that impact your tax liability? ›

Here are six of the biggest factors in calculating income tax:
  • Taxable Income. The federal tax system is progressive, meaning that generally your tax rate increases as your income increases. ...
  • Filing Status. Besides income, the taxes you pay depend on your filing status. ...
  • Adjustments. ...
  • Exemptions. ...
  • Tax Deductions. ...
  • Tax Credits.
Sep 16, 2022

What is considered a high earner? ›

Based on that figure, an annual income of $500,000 or more would make you rich. The Economic Policy Institute uses a different baseline to determine who constitutes the top 1% and the top 5%. For 2021, you're in the top 1% if you earn $819,324 or more each year. The top 5% of income earners make $335,891 per year.

What is a high-income earner for 2023? ›

Are You a High-Income Earner? A high-income earner for the 2023 tax year earns more than $578,125 for single taxpayers and $693,750 a year if they are married and filing a joint tax return. For 2022 and 2023, the tax rate for high-income earners is 37%.

How do I invest my business profits to avoid taxes? ›

7 ways to minimize investment taxes
  1. Practice buy-and-hold investing. ...
  2. Open an IRA. ...
  3. Contribute to a 401(k) plan. ...
  4. Take advantage of tax-loss harvesting. ...
  5. Consider asset location. ...
  6. Use a 1031 exchange. ...
  7. Take advantage of lower long-term capital gains rates.
Nov 30, 2022

How do business owners avoid taxes? ›

7 Ways Small Business Owners Can Reduce Their Tax Bill
  1. Pay for health insurance.
  2. Save for retirement.
  3. Claim the qualified business income deduction.
  4. Using your car for business purposes.
  5. Depreciation expense.
  6. Home office deduction.
  7. Financing costs for the business.
Feb 2, 2023

Does LLC protect you from IRS? ›

Limited Liability Company (LLC)

For state purposes, an LLC is a business separate from its owner in which the owner is protected from the LLC's acts and debts, such as bankruptcy and lawsuits. For federal tax purposes, an LLC is disregarded as separate from its owner, therefore is liable for taxes.


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