At a time when top combined federal and California state income tax rates approach nearly 50%, and many tax breaks are set to expire soon, understanding the basics of tax planning is crucial if you want to secure your financial future.
Drawing from over three decades of experience, I have distilled the top five tips my affluent clients have embraced to mitigate their tax burdens. These are not just tax angles but empowering tools designed to help you grow your wealth.
Learn how to think about taxes
To keep more of what you earn, you need to do the following: reduce taxable income, defer taxable income, increase deductions, accelerate deductions, and reduce the rate you pay. Every tax planning technique meets one or more of those objectives. Let’s use a simple retirement account as an example.
You increase deductions and reduce taxable income when you contribute to retirement plans such as 401(k)s or IRAs. For instance, if someone earns $100,000 and contributes $10,000, their annual taxable income is reduced to $90,000. Simple, right?
Since you are not taxed on the retirement income until you pull it out, you are also deferring taxes on the investment income and will also pay at a lower rate when you are retired, when your income is supposed to be less.
Therefore, with a simple retirement plan, you are increasing your deductions, decreasing taxable income, deferring taxable income, and paying taxes at a lower rate! Now, imagine what you can do with more complex planning.
You must invest
You can also defer taxable income when you buy assets like growth stocks or real property because you often do not pay taxes until you sell the assets. In many cases, even if you dispose of the assets, you can eliminate all or part of the income tax on the disposition with tax and charitable gift planning.
You reduce your tax rate by having investment income because the regular top federal tax rate is 37%, but the rate on sales of assets and most dividends is only…
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