Organizing my tax information prompted me to write on this topic. Coincidentally, I ran across an article on the topic by Elaine Floyd, CFP® and Richard Koreto, who I credit for this list of questions, but which I have adapted based on my experience.
As will become clear from this discussion, it is important to treat taxes as more than an annual event at April 15th. Taxes have potential to impact our finances at least as much as market rates of return, yet much of the energy surrounding financial planning can get diverted to investments. Please don’t misunderstand me; designing a portfolio to a suitable risk level is huge in the projections we make. But taxes loom large, too, and from a planning standpoint, you may have more control over reducing your tax burden than over the impact markets have on your portfolio.
Also, as much as I or any other financial advisor may raise tax issues, there is no substitute for a specialist in this area. There are many general guidelines, but they are really intended to be applied with care to an individual’s situation, which is where a tax specialist can add value. If you do your own taxes and begin to sense complexity as you read the following questions, then you may want to consider finding some outside help. You may recoup far more from good tax planning than the fee paid for the service.
Having said that, I have found from my own and my clients’ experiences that sometimes we have to ask for the planning advice. It is easy for even the best tax people to become buried in the tax preparation work, especially if they are good and carry a full client load. So armed with these questions, you may want to make some inquiries in order to maximize your relationship with your tax advisor, as well as communicate back those findings to your financial advisor. When doing so, it is nice to ask your tax advisor when they are ready later in the year, which may include a break after April 15th!
With that introduction, here is Floyd and Koreto’s suggested list of questions.
1. Will a life event or major purchase affect my taxes?
Many life events can impact taxes: births, adoptions, marriages, separations, divorces, or deaths. Have children left the nest and started jobs, changing deductibility status? Have they reached a milestone birthday, like age 18 or 21? Has a death resulted in an inheritance? If so, and it includes an IRA or 401(k), proper management of the inheritance will be critical to tax consequences. Major purchases like a second home may mean some additional deductions.
2. What will my tax bracket be in 2014?
Your tax bracket is the rate at which the last dollar of income will be taxed, and it helps calculate the tax efficiency of investment or planning proposals. A paycheck is only one factor, so be as comprehensive as possible in determining this number.
3. Can you help me estimate my income for 2014?
As in item #2, you will want to go beyond salary. Bonuses, freelance assignments, investment income and more play a role. And it’s not enough to know gross income. It is also important to have an idea of adjusted gross income, modifications to adjusted gross income and taxable income.
Why is all this important? Different tax rules use different thresholds for various types of income. An accurate estimate of income allows you to manage different types of income to manage the tax bite (this can be especially important for retirees who may be withdrawing from different types of assets for living costs).
Of course, your tax advisor will need some realistic information from you. But even if it is not precise, some kind of planning is better than none.
4. Do I have any remaining loss carry forwards going into the coming year?
Loss carry forwards are tax losses as a result of selling investments at a loss. The IRS only permits deducting investment losses to the extent that they are offset by gains and by regular income of up to $3,000 a year. Any losses in excess of this can be carried forward to future tax years.
This is a number that can be very helpful to you and/or your advisor in managing your portfolio. For example, those losses may be helpful in adjusting a portfolio’s asset allocation. After last year’s major rise in the stock market, it may be desirable to sell some stock if it is above the risk guidelines for your portfolio. However, in doing so, it is nice to avoid generating taxes in the process; hence, a tax loss carry forward, if one exists, is great to use.
In addition, “tax loss harvesting” has traditionally been a year-end activity, but ideally it should take place throughout the year as investment opportunities present themselves.
5. Am I eligible for a Roth IRA conversion? Is it recommended?
A Roth IRA conversion allows workers to convert traditional IRA assets to a Roth to avoid taking required minimum distributions in retirement and avoid paying tax on any distributions taken. A Roth conversion involves paying taxes on the assets converted. A tax specialist can estimate the tax that would be due on a Roth conversion.
In addition to the tax calculation itself, be sure to ask about strategies to reduce the tax bite. Would a partial conversion be appropriate? Sometimes a conversion is an issue of timing and/or amount, rather than an all or nothing decision.
Your tax advisor may have a strong opinion on a conversion. When having this discussion, please remember that no one has any visibility on tomorrow’s tax code structure, so much of this decision may have to be made on what we know today. It would also pay to circle back to your financial advisor, since this decision can impact investments, retirement planning, charitable giving and possibly legacy planning.
6. Should I increase my retirement plan contributions?
The IRS maximums have not increased for retirement plan contributions this year. However, some income phase-out limits have increased, so this may be a beneficial conversation to have.
7. Do you have any recommendations for reducing my 2014 taxes? What about 2015 and beyond?
Tax laws have changed a lot recently and added complexity to some planning. Some strategies may be complex, particularly for high earners. You may need the input of both your financial and tax advisor for those. However, because you may earn less, don’t assume you can’t benefit from discussing this question with your tax advisor.
8. Should I change my withholding for 2014?
This is an area that may help your cash flow, particularly if you decide to save more through payroll deductions to 401(k)s or other savings plan. Many other situations may mean a change is in order: changes in family or marital status top the list. If you have been getting large refunds, you may need to make a change so that you are not making a large loan to Uncle Sam when you could have been paying off debt or investing the funds. On the other side of the coin, you may need to have more withheld if you have a large portfolio, unless you prefer to make estimated tax payments.
Also, you may need to make different adjustments for state withholding than for federal—yet another reason to have a good tax expert in your circle.
9. Is there anything my financial advisor can do to help my tax situation?
Ideally, the members of your financial “team” should work together. Financial planning and taxes go together like a hand and glove. The better informed each advisor is about your situation, the better solutions we can develop for you. I welcome such information and encourage clients to consult with a tax expert on the issues we are facing.
With these comments, I will close and wish you a happy tax filing season!