The most common tax mistake people make is happening right now. Not doing tax planning. Or thinking that because they had their tax return done for 2021, there's nothing more to do.
The biggest way to save money in taxes is through great tax planning. We'll talk about what that means so that you avoid common items that people overlook and legally pay less in taxes.
We talk about how to do tax planning now. We cover:
What to look for in different stages of your life.
What do we mean by planning? How do you do it?
What to look in last year's tax return that can really help you this year.
What types of move you may make now based on what your situation is like this year. For instance you might put more money in your 401K, sell some stocks or make more charitable contributions because now is a better year than next to do that, based on your income.
We talk about benchmark years--when often big things are happening that you can do planning around. For instance, turning 72 might matter, or taking social security, or simply getting a new job.
It's work paying for tax planning--probably more than for tax preparation. Tax planning is where the saving is.
Here's Bridget's firm website: https://www.sullivanmermel.com
John's firm website: https://www.trinfin.com
For advisors around the US: https://www.acplanners.org/home
Thanks for watching and please subscribe!
TRANSCRIPT
John: Now that April 15 is passed, taxes are done for the year. Right? Au contraire. The biggest mistake that people make is at this time of the year on their taxes. We're going to tell you what that is and how to fix it on this episode of Friends Talk Financial Planning. Hi, I'm John Scherer and I run a fee-only financial planning practice in Middleton, Wisconsin.
Bridget: And I'm Bridget Sullivan Mermel and I've got a fee-only financial planning practice in Chicago, Illinois. Before we start about the biggest mistake, please, I’d like to ask you to subscribe. It helps us with the YouTube algorithm and helps the channel. So, John, let's talk biggest mistake.
John: Yeah, so here's the spoiler alert: the biggest mistake is not doing tax planning. Planning, not preparation. So there we can end the discussion, right? Quit the video. No. So you want more information on what planning is? Let's talk about that. Because I talk with people and they say, “Oh, yeah, I've got my tax guy. Yeah, they do planning. They tell me what to make for estimated payments. I got my plan for the year.” Not exactly how we do things.
Bridget: That's good. That's better than not having as many payments. However, that's not proactively planning. For me, the metaphor I use is I want to paint my living room and I go downstairs and just look and see what paint is around and what materials are around. And I use that to paint. Okay. If that's my plan, that's what doing your taxes after the fact is like.
John: Right. You can do it. You can paint your house. I have enough paints in the basement. I could paint my house.
Bridget: But it’s not going to look as good as if I planned.
John: Yeah, that's exactly right. What we mean—and I think we operate similarly on this, Bridget—is that planning is taking a look at, okay, what happened last year, and then what do I think is going to happen this year? Is my earned income going to be the same? Or is my investment going to be the same? Or my deductions? And look at, okay, if last year is exactly like this year, what does it look like? And then what sort of changes do I expect to make? And then taking a look at what things could I do about that. And looking and going, “Oh, geez, but if I do this or if I do that, put more money in my 401K, make more donations to charity, or if my income is variable like yours and mine are, or if you run your own business, what does it look like this year? Or if you're a salesperson? Those sorts of things. That's sort of one of our approaches to things: taking a look at last year versus this year and then what decisions can we make this year?
Bridget: Right. To optimize our taxes.
John: That's right.
Bridget: So I would say that often with people who are younger and have regular jobs, we're looking to make sure that their 401K contributions are what they think they're going to be. We also check itemizing and if there are any opportunities there because some people itemize some years and some people don't itemize other years.
John: Right. And itemizing—just to throw the jargon police in there—that’s for things like donations to charity. Some years you get credit for it. Some years it doesn't really do any good for you so you need to take a look at that each year. Right. Those sorts of things.
Bridget: Right. Another item is when you're older. You have a lot of opportunity in the years before you retire and then transition to retirement. Then other items benchmark when you start taking Social Security and when you start taking money out of your IRAs.
John: When you have to.
Bridget: When you have to or when you do. Some people take money before they have to. So those are all benchmark years and there's a lot of planning you can do around them to make sure you're optimizing things.
John: So one of the things that I appreciate you saying about having these different benchmarks and especially as you get older, right. You retire, you take Social Security, you have to take money out of your IRAs… One of the things we always talk about with folks is that when you have changes in income, those are huge opportunities.
Bridget: Right.
John: Income goes way up, there's opportunities, or income goes way down. One of the things we're talking about is how we’ve had folks over the years that have sold businesses, sold big investments and things that have either gone up or down, taking different jobs or retiring. Maybe you got laid off and you're still looking for a job. This is an opportunity, right. It's a bad deal from “Jeez, I don't have my income that I wanted.” It's a good deal because you say, “Listen, how can we make lemonades from the lemons, right?” I get a new job.
We had a client that was taking a new job, and he was getting a big sign-on bonus to take this job. So we looked at his taxes. Here's what it was last year. Here's what it's going to look like next year. And this big signing bonus was able… I said, “Well, listen, if you have to take it all this year, here's what we think it's going to look like. If the company would be willing to say, ‘Geez, instead of paying it to you in November, let's pay it to you in January’ what that might look like?” And it was an $8,000 or $10,000 savings just because of where his tax, where his sales job was. He had big commissions this year and he's starting from the ground next year, those sorts of things.
Seemingly innocuous, right. “Hey, I got a nice raise. This is going to be a good opportunity.” But by being proactive… because if we had waited until April, the opportunity is gone. Those sorts of things, such as when you have big changes. Those big changes would be when I start taking Social Security, when I get to retirement, those types of things. Those are the real opportunities. Those are one place where, you know, “Hey, if I'm going to have a change in income, golly, that tax planning can be golden for me.”
Bridget: Right. And I think another major area is when you get to retire early. When you're retiring early, you have a lot of tax planning opportunities. So I had one couple that I was working with that was able to take advantage of the premium tax credit. Okay.
John: For their health insurance.
Bridget: Yeah. So they were able to take advantage of that. Because once you're retired, you have a lot of control over your income that you don't have when you have a W-2. When your W-2 rolls in you just have to pay tax on it. You have no options.
John: Good news, you get a paycheck every two weeks, right. Bad news is you have less flexibility from a tax standpoint.
Bridget: There's this idea out there that the rich don't pay any taxes. Well, if the rich get the money on a W-2 they're probably paying a lot in taxes. Okay. That is my experience. There's not really any way around it. So when you get a W-2 you don't have that much flexibility, but, when you don't have a W-2 and you're retiring, you have a lot more flexibility. So, again, that's when you can take advantage of things like the premium tax credit and that requires keeping your taxable income looking lower.
John: That's right.
Bridget: We manage people's cash flow with that in mind. It's very integrated tax planning with their cash flow planning. Those are people that are retiring early.
John: I was just going to say we were talking with a client here recently and they're planning to retire in like three or four years. They talked to a friend and said, “Geez, they have no income and they're getting the premium tax credit, and that's a good. How do they have no income?” And so one of the things we talk about with folks is well, if you pile up money in the bank right before you get to retirement, taking money out of the bank is not a taxable event.
And then—I think this is really important to bring up, too—when we talk about tax planning, it's not “Well, look at these two things and then do your plan.” It's not, “What are your estimated payments?” That's part of it. But there's all these things that come in and we're talking about doing what we're doing here: Does it make sense to have no income to get that premium tax credit? Or are you better off by taking money that's in your retirement plans and turning it into a Roth IRA, perhaps?
Bridget: Right.
John: Or selling some stocks that have gone up and paying 0% capital gains taxes? But, when you do those things, then you’ve got to be careful of the Medicare limits and then you have to be careful and then that ties in with, and so on … and it's this multi-step process. It's not different than maxing out your 401K. There's some complexity, but, golly, there are three steps so we can do it. This is a thing where you can't just take a look. I mean, you have to actually run the numbers and look at how these things all interact. It's complicated. It's worth paying for advice. I guess maybe that's one of my points here. You think, “Well, geez, I just paid a big tax bill, had my taxes done two months ago. I don't have to think about it.” This is an investment and some advice now that really can pay off in the future and I mean hundreds or thousands of dollars by being proactive on things.
Bridget: Yeah. In my experience, I had a tax practice. This was years ago and I had a lot of frustration because I felt like even though I'd ask clients to come in for planning meetings they didn't want to pay for it because I was charging hourly, which is understandable. So then when I switched over to financial planning and using a retainer model, it was included. Then people were like, “Oh, this is included. I guess I better do it.” So that is one of the things that I love about my business now is that we actually do tax planning so that we can get in on the action. That's where the action is with taxes. It’s in planning. It's not in execution.
John: And most of the tax preparers are built to report what happened, which is not… I mean, you need to do this stuff, right? But that bang for the buck. I'll share just one other quick story, or maybe two stories if we have time. We have a client and they run a medical practice and they bought a bunch of equipment one year. They had a business tax person, a business CPA, a personal tax person. And I said, “Well, how are you going to handle deducting that?” And he said, “What do you mean?” I said, “Well, you have two choices. You can spread it out or you can take it in one year.” I remember the wife saying, “Why didn't Jim our tax person tell us this?”
Well, you know, the business guy wasn't talking to the personal guy. Neither one of them was talking to the investment folks when we came in. So I said, “Well, it might make sense to ask your folks and see if you deduct it all in one year, or maybe your income goes down to zero, and then you can take some money in your IRAs and turn it into Roth IRAs, and money you deducted at 25 or 35% and for 0% or 10% turn it into tax-free money in the future and save like $25,000 in taxes by making this transition.” So we were able to do that. It's not that the tax folks were bad or not doing their job. It's just that's not what they're designed to do.
And we had another person came to us after a year. They had a big investment in real estate and it lost money and it was, I think, a six-figure loss, if I remember right. And so they had negative income. They had zero income. They didn't have to worry about tax planning. Except for, had they taken some of their retirement plan money, they could have turned it. If they had $100,000 lost, we could take $100,000 and make it tax-free for the rest of their lives. But again, the CPAs aren't wired to do that proactive thinking. So that's why, to circle back on things, the biggest mistake people make is not planning today for this year. Next spring is just reporting. This is the time when you can really make a difference in your tax situation.
Bridget: So when people want to do tax planning, where is the best place to get it? I think a good place to start, actually, is your CPA. Because, calling them now, they will be so happy to hear from you at this time of year. If you're saying, “Hey, can we set up a meeting just to do some tax planning? I want to take a look at what happened last year and make sure I'm planning for next year.” But some people aren't necessarily designed to do that.
What are your other suggestions? Well, a completely unbiased opinion is that you should go to the Alliance of Comprehensive Planners 😊. Bridget and I are both members of ACP. We're fee-only tax focused financial advisors, and there are people that do what we do out there. The CPAs, I absolutely agree, those are the folks that are in the weeds with it. Ask them. Ask your financial adviser for help on this and if your person doesn't give tax advice, ACP is a great place to go, but find somebody who can bridge that gap. There are people out there like us that do that.
Bridget: Great place to wrap up! I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago.
John: And I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. Before we go, remember to hit that subscribe button to help other people find this information. And if you like what we talk about on our show please do visit acplanners.org to find an Alliance of Comprehensive Planners adviser in your area. Thanks. See you next time.
At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.