Go to Top

Federal Income Tax (Podcast)

Something Personal Episode 14: Federal Income Tax

Something Personal logo.Whether tax season scares you or just makes you groan, it likely is not your favorite time of year. But tax planning doesn’t have to be painful, and it shouldn’t be restricted to a few weeks in the spring. Getting a grip on your taxes means integrating tax planning into your overall financial plan — and, as a bonus, it means taking the pain out of Tax Day. Senior client service manager Benjamin C. Sullivan returns to “Something Personal” to demystify the U.S. tax system. Ben explains why it’s critical to think about tax planning as long-term lifestyle choices and not one-off quick fixes. He also challenges common misconceptions, emphasizes the importance of playing by the rules, and shares the reasons he can’t stop talking about investment planning in a tax-focused episode. Ben’s talk with host Amy Laburda has something for everyone, from listeners looking for advanced tax planning techniques to those hesitant to admit they aren’t entirely sure what a “tax bracket” even is.


About the Guest

thumbnail of Ben Sullivan headshot. Benjamin C. Sullivan, CFP®, CVA, EA, joined the Palisades Hudson staff in early 2007 and became a manager in 2010. In 2016, he established the firm’s branch office in Austin, Texas, where he currently resides. A native of East Hanover, New Jersey, Ben graduated magna cum laude from Tulane University’s Freeman School of Business with a degree in finance and legal studies in business. He is among the authors of the firm's book Looking Ahead: Life, Family, Wealth and Business After 55; his chapter on federal income tax served as the basis for this episode. For Ben's full biography, click here.

Episode Transcript (click arrow to expand)

Amy Laburda 00:06
Welcome to “Something Personal,” the podcast where we almost always wind up talking about taxes somehow, but today we're dedicating an entire episode to them. I'm Amy Laburda, the editorial manager at Palisades Hudson Financial Group. Today's guest is my colleague, senior client service manager Ben Sullivan. Thanks for coming back on the show, Ben.

Ben Sullivan
Thanks for having me, Amy.

Amy Laburda
So, Ben, this is going to be a pretty boring episode, huh?

Ben Sullivan
Yes. But in all seriousness,

tax implications are a key part of everything we do as financial planners. And I don't think that's a surprise to you, since almost basically every episode of the show has touched on taxes to some extent.

Amy Laburda
OK. While not a lot of people get excited about taxes, I will grant you that it's definitely important. It's another one of those topics that's good for anyone to know about, regardless of where they are in life. So going back to another common refrain on the show,

we often tell people that it's best to get help from a trusted financial planner with some of their planning. And it seems like one of the ways you can evaluate whether you found a good financial planner is to know a little bit going in, certainly about taxes, so you can tell if the person is making tax-aware recommendations. Do you agree that's something good to look for?

Ben Sullivan
Exactly. I like to say it's not about what you make, it's about what you keep after taxes that's important in basically any financial decision.

Amy Laburda
OK, so

where should listeners begin to think about their tax planning?

Ben Sullivan
To start with, there are a few cardinal rules of tax planning. First, you want to make sure that you don't do any harm. You don't want to jeopardize your long-term financial well-being to minimize your tax bill. It's just not worth it. You don't want to do things today to avoid taxes that might be penalized down the road. For instance, you might be able to save $5,000 in taxes by putting $20,000 into a 401(k). But if you need it before you're at retirement age,

you might wind up paying $7,000 in taxes and penalties to access the money. So if you want to get that money back out, and you wind up paying more in taxes and penalties, it's not worth putting it in in the first place. So you really have to plan kind of more for the long term than just for the current year that you're in. And then the second rule of tax planning, I'd say, is that you want to play by the rules. Tax avoidance means using legal means to minimize your tax bill.

And this is absolutely acceptable and is what we help our clients with often. But tax evasion, on the other hand, is illegal and would be fudging the numbers or otherwise lying or breaking the rules in some way to lessen your taxes.

Amy Laburda
Have you genuinely run into people who want to try cheating, tax evasion?

Ben Sullivan
I feel like they're not really trying to cheat the tax system at all. It's just it's misconceptions about what you're really,

like, doing. People don't realize that it's tax evasion. Sometimes you hear people talk about “How much can I deduct without triggering an audit?” or “Do I have to report business income that I receive in cash?” It's like, these are just things that you hear out there in — when you're in your everyday life. And it's like, they're not talking about tax evasion purposely, but they are talking about tax evasion. So those aren't the kind of discussions that we have for tax planning. Maybe someone hears a zany idea on

TikTok about how to save a bunch on taxes. We're all about helping people avoid taxes, but we don't want to get our clients in trouble. Typically anyone who talks to anyone at Palisades Hudson realizes that it's not really worth it. There's too much to lose from kind of fudging the numbers, getting yourself in trouble, whether it's any kind of regulatory issues, penalties, or even just, like, you can lose some of your accreditations — doctors, typically.

You don't want to save $10,000 on taxes and then not be able to practice medicine going forward. So not worth trying to skirt the rules.

Amy Laburda
Absolutely. So let's back up for a moment and talk sort of “big picture” about the federal tax system and how it works, basically.

Ben Sullivan
Right. So I can try to bore everyone to death with technical terms. There's an unlimited number of technical terms. I've been doing this for over 16 years, and I still run into new terms. So I'm going to skip a lot of those right now.

At the most basic level, you start out with your gross income, which is all of your income from any source. This includes your salary, but also profits from the sale of stocks or real estate, gambling winnings, all sorts of income. Once you start making adjustments, you wind up with your adjusted gross income. So your adjusted gross income is after your, what they call “above-the-line” deductions, but before the “below-the-line” deductions.

Below-the-line deductions bring you to your taxable income. If you're thinking about above-the-line deductions, that would be something like a contribution to a health savings account. And then below-the-line deductions are itemized deductions, which is what most people think about, like medical expenses, state and local taxes, and charitable deductions.

Amy Laburda
OK. I feel like one term that probably everyone has heard in relationship to taxes is the word bracket, but

maybe not everyone listening is totally confident about what that actually means. So what is a tax bracket?

Ben Sullivan
Right. So we have a progressive tax system that taxes higher brackets of income at higher rates. So when you have more income, it's getting taxed at a higher rate. However, the important thing to remember here is that not all of your income is taxed at your marginal tax bracket rate. So the highest tax bracket right now is 37% for married filing

jointly couples, if they're making around $694,000. Let's just take an example. A married couple making $800,000 would be in that 37% bracket, but only about $106,000 of their income would be taxed at that rate. The rest of their income would be taxed at lower rates, the same rates that you and I probably are incurring.

You need to fill up each lower bracket before spilling into the next bracket. So while it's still a very large tax bill for a married couple earning $800,000, the overall effective tax rate is closer to 28%, rather than their marginal rate of 37%.

Amy Laburda
So you're basically filling up each bucket with dollars and then,

once you get to this certain threshold, that's when they start getting taxed at the next highest rate.

Ben Sullivan
Yeah. You hear people and it's like, “Oh, I got bumped up into the 37% tax bracket. It wasn't even worth making that last $10,000,” because they think that it's now 37% on everything, but that's not how it works.

Amy Laburda
Besides income level, are there any other factors that determine how much federal income tax someone owes?

Ben Sullivan
So I think a lot of people think that bonuses are taxed at a different rate than other income.

But that's a misconception as well, because there's different withholding on bonuses. They might withhold a higher percentage of your bonus as federal income tax, but it's not actually being taxed at a different rate. It all evens out at the end of the year. The most common income that's taxed at a different rate is qualified dividends and long-term capital gains. Both of these are taxed at 15% for most people, 0% for lower-income individuals,

and 20% for high-income individuals. And then there's also the 3.8% net investment income tax, which applies to investment income over a certain threshold. And this would be income from dividends, annuities, royalties, rents, passive activity income, and most capital gains. But like I was saying before, bonuses don't get taxed at a different rate. It's not like they're penalizing bonuses.

Amy Laburda
OK. So we've covered what

a person may need to pay in federal income tax. What about when they should pay it?

Ben Sullivan
So the first important thing to remember is that it's a pay-as-you go kind of tax system. A lot of people are paying throughout the year through withholding from their paychecks. They're not really thinking about it. But people who are self-employed or have a lot of investment income, they need to make quarterly estimated tax payments. So essentially, you need to pay 110% of your prior year's tax liability throughout the year,

quarterly, or at least 90% of your current year's tax liability. Otherwise, there can be underpayment penalties and interest throughout the year. And with higher interest rates, those penalties have increased over the past couple of months and quarters. So April 15th is when you settle up. Everyone thinks about that as Tax Day. You wind up filing your tax return for the previous tax year and you look to see if you're overpaid or underpaid, and then you pay the difference or get a refund. And of course, it's hard to

estimate what your taxes are as of April 15th sometimes, because a lot of times our clients are invested in private equity investments, or they operate private companies, and the tax information, tax reporting for those companies aren't available by April 15th. So that's when we say that the clients have to go on extension. You have to estimate what your entire tax liability is as of April 15th and pay in that total liability,

but you don't have to actually file the returns, get all of the numbers down. So you kind of make a best-guess estimate. And we generally advise people to pay as much as they can at that time and prepare as much of the return as possible, so that there's not so much uncertainty.

Amy Laburda
Yeah, I'll admit, before I worked at this firm, I did not know that there was effectively a fall tax season also, for people getting an extension.

Ben Sullivan
Yeah, so my friends always know that I'm

kind of busy around April 15th, and then it winds up being September, beginning of October, end of August. And I'm like, “Yeah, I'm really busy.” And they're like, “Why?” I'm like, “Well, everyone has a six-month extension. So we're able to still be working on taxes.” So you get a kind of a lull throughout the summer season. And then it seems like you have these deadlines and

partnerships, they need to report all their information by September 15th. So we're just kind of in a holding pattern for an extended period through the summer. And then everything kind of starts flowing through as that September 15th deadline [approaches]. And you can finalize everything, get all of the i's dotted, t's crossed, and file by October 15th, the extended due date.

Amy Laburda
All right. So we know about tax brackets. We know about tax deadlines. Let's reward our listeners for hanging through all of that with some actual advice.

So, what are some strategies you talk with your clients about for legally minimizing the amount that they have to pay in income tax?

Ben Sullivan
Right. First, I need to caveat with a phrase that I see all the time, please consult your tax adviser. Usually, I am the tax adviser that people need to consult with, so I can't wiggle out of concrete answers. It's one of those things. Everyone's just like, “Consult your tax adviser. Consult your tax adviser.” And then I have to actually answer the questions. But when we’re on this podcast, I cannot give

specific tax advice for anyone's situation. The right thing for one person to do can be the exact wrong thing for another person to do, or even for that same person in another tax year, in another situation. But I do like to start with a framework of how people should think about minimizing their taxes. I don't think that tax planning is about one-time tips and tricks. It's about structuring your life in a tax-efficient manner, to the extent possible.

Really, the long-term tax planning techniques can be broadly broken down to a couple different categories. It's the way I think of things so that it's not just like, “Hey, here's your one tip at the end of the year.” It's the rules to live by throughout your life to create that structure that allows you to live that tax-efficient life. So really, I think about trying to reduce income, control the nature of income, optimize the timing of income and deductions,

and then take advantage of credits and incentives in the tax code.

Amy Laburda
OK. Backing up just a moment, I know you are a dad, so I forgive you being into dad jokes, but are you really suggesting that people make less money with the reducing income step?

Ben Sullivan
Isn't that financial planning 101? Reduce your income? No, but in all seriousness, there are ways to reduce your taxable income without reducing your total real income. I break them down into four categories. I'm kind of doing that thing where you

you number things, and a couple different ways to tax plan, a couple different strategies for reducing your income while not really reducing your economic income. So you can decrease your earned income, you can decrease your AGI or adjusted gross income, you can decrease your portfolio income, or you can reduce your taxable income.

Amy Laburda
Can you give us some examples of what these techniques would look like?

Ben Sullivan
Sure. When you're looking at your earned income,

you can try to reduce that by making contributions to an employer retirement account, a 401(k) typically — if you're employed as a teacher or for a non-profit, a 403(b). You can take advantage of pretax benefits, or dependent care or flexible spending accounts. You can also reduce your AGI by making contributions to a traditional IRA in certain cases, if you're not covered by an employer IRA, employer retirement plan. You can also make contributions to SEP IRAs, for

self-employed individuals, or to health savings accounts.

Amy Laburda
OK. So you get an upfront tax deduction for contributing to these tax-advantaged accounts. But are there other tax benefits to making these contributions?

Ben Sullivan
Yeah. This is exactly what I was talking about when I said structuring your life in a tax-efficient manner. So it's not the one-time advantage that you're really looking for. By putting money in tax advantaged accounts, you get the upfront savings and then annual savings from having less money

in your taxable account as well. So these same strategies are good for reducing your portfolio income, as well as reducing your current earned income. And then in the same vein, you can also reduce your family's overall income through funding a 529 education savings plan. Again, this works if it's money you'll want to be saving anyway for a child or a grandchild, or really any person's education. So if you're not in a position to fund one of those accounts, you can

still make your portfolio more tax efficient in other ways. I'd say investing in funds that don't trade as frequently and investing for the long term will be more tax efficient than trying to be a stock trader or anything like that. When you, or your tax-minded financial planner, look to manage your portfolio, you can consider rebalancing it by adding new funds in underweight asset classes, rather than selling

existing investments in overweight classes and generating a tax liability from the capital gains that you realize there.

Amy Laburda
Makes sense. And if it doesn't fully make sense to listeners, a quick plug to go back and listen to Ben's earlier episode about investing, which I think will be useful context for that strategy. So a listener has now done all they can to reduce their earned income, whether an IRA, 529, a lot of the other techniques you've mentioned. So once they've done that, what's the next step?

Ben Sullivan 15:28
So then we look at deductions. So for most taxpayers, there are two choices: to take the standard deduction or to itemize your deductions. For most people in America, it's going to make the most sense to take the standard deduction. They increased the value of the standard deduction. So for a married couple currently, that's $27,700. So most people, when you add up all of their itemized deductions, it's not more than that amount. But a lot of our clients have a large mortgage or

donate a lot to charity, and then they can benefit from itemizing deductions. Another change that's happened recently is the state and local income taxes. You used to be able to deduct an unlimited amount of them. So if you had a large home or if you lived in a state that had high state and local income taxes, you'd automatically be paying tens of thousands of dollars in these deductions, these state and local tax deductions,

and then it would allow you to benefit from itemizing. But now whether you're single, married filing jointly, head of household, all of those have a $10,000 cap on what we call the SALT deductions. So that's kind of like, I think of that as your “gimme.” Like basically everyone pays $10,000 in state and local tax deductions. So then you have to get the next $17,700 in additional deductions in order to be able to itemize.

So for our clients, like I was saying, it's [a] large mortgage, a lot of donations to charity, and then you can wind up benefiting from itemizing. So you want to keep in mind that these itemized deductions are not the same as business expenses. If you have any kind of business that you're operating, you can deduct things. You don't have to exceed that $27,000 threshold. If you have a side gig, that all works as well. So the itemized deductions are the very specific things I was saying, like the interest on your mortgage.

Amy Laburda 17:25
And not to get too deep into the policy weeds here, but the standard deduction was raised in the 2017 package. Is that something that people can expect to stay? Go away? Too early to say at this point.

Ben Sullivan
I'd say it's too early to say. I think that it does simplify the tax code quite a bit for a lot of people. And I could see, it's… Once they give you a benefit, it's hard for them, the government, legislature, to take that benefit away.

I think they'll wind up extending that.

Amy Laburda
Makes sense. So you previously mentioned controlling the nature of income. What did you mean by that phrase?

Ben Sullivan
Like I said before, qualified dividends and long-term capital gains are taxed more favorably than other types of income, like earned income or interest income. So if you're able to earn more long-term capital gains and qualified dividend income, that can help you pay a lower tax. The easiest way is to be a long-term investor,

rather than a short-term trader. This is how you wind up with billionaires paying lower tax rates than people who are just high-income, because that earned income is taxed at a higher rate than capital gains. And then another benefit of prioritizing income through capital gains is that you don't owe tax on an asset until you sell it, and you can decide when that timing works for you.

Amy Laburda
That sounds great, but I will note that it doesn't sound like this is a thing that everyone can necessarily benefit from.

I know I personally can't just turn my W-2 income into a long-term capital gain, though I would love to.

Ben Sullivan
It would be nice, wouldn't it? While controlling the nature of income has lots of constraints, there's ways many people can do it. One way that I love to think about it is with investments. When you're pursuing investments and you're holding different types of investments, you want to

understand the most advantageous place to position that investment. So interest rates are currently around four to five percent right now. A lot of the longer term is a little bit lower. The near term is around 5%. Sometimes you can even get a little bit more than that. So let's just go with 5%. If you have a million dollars in bonds right now held in a taxable account, that would be about $50,000 of annual income. Or, on the other side, about

$20,000 in federal taxes for high-income individuals. So while these higher interest rates are nice, it is creating more of a tax burden at the same time. But if you hold these bonds in a tax deferred retirement account, like that traditional 401(k) or traditional IRA, you'd pay no income tax currently. If you had, say, generated a 5% return via capital gain in a taxable account, so like a long-term capital gain, none of that would be taxed

if you didn't sell. And if you sold all of the investment after one year, you'd only owe $11,900 instead of $20,000 of tax on the interest income.

Amy Laburda
That's a substantial change.

Ben Sullivan
Yeah. It's especially important to consider asset location when interest rates are high. And this is just one example, but there are huge savings possible over a lifetime by knowing where to keep different types of investments and how to tap into them tax efficiently.

So, I think it's really important to kind of go over that for a little while, because it's hard to understand. It's like, OK, you generate a 5% rate of return and it's not always a 5% rate of return that is spendable money. So, that's kind of why when we think about managing portfolios, we think about a “total return” basis, as opposed to focusing on income. Because focusing on an income-based investment philosophy

is not necessarily tax efficient.

Amy Laburda
That makes sense. So it's not just about the number of dollars that you get in interest or in gains, but in what actually then comes to you and you don't have to give to Uncle Sam.

Ben Sullivan
Right. And that's where, when we think about investments, we think about asset location. And that's the part where it's like, “Wait, I thought this was a podcast about federal income taxes and federal income tax planning.” And it's like, “Well, I can't stop talking about investments if I'm talking about

how to manage someone's financial life in a tax-efficient way.”

Amy Laburda
Yeah, it makes sense. It's all kind of entangled a little bit more than the neat divisions of the episodes might suggest. So I hope that's interesting and not frustrating to our listeners. So we've talked about a lot of these strategies that you suggested.

What other kinds of income do we need to think about when we think about our taxes?

Ben Sullivan
So one I'll touch on briefly is passive income, which can be from rental properties, or partnerships, or S corporations, where you're more of just an investor, not really the person operating those businesses full time. While it's not taxed at a different rate than other income, it's subject to a lot of detailed rules that keep accountants in business, really. Passive income can only be used to offset gains from other

passive income. Really, it's the losses from passive income, passive income properties, that can offset the income from passive income properties. Although it's similar to portfolio income, it's not the same thing as dividends and interest. So if you operate a rental property, have a $25,000 tax loss because of depreciation, interest expense on that

rental property, you can't say, “Hey, I had $25,000 of dividends, let's just let those two offset.” So there's a lot of detailed rules where you really get into the minutiae. But at the same time, when you have detailed rules, you create planning opportunities in terms of how you report the income and whether you really meet the certain criteria that you are able to avoid these passive activity rules.

Amy Laburda
Sounds complicated enough to not get further into those weeds right now, but I think that the takeaway is:

If you're dealing with rental property income, definitely a good time to talk to a tax professional who can give you some solid advice.

Ben Sullivan
Yeah. The tax reporting on those kinds of investments get a lot more complicated, and it's always possible to do it on your own. But when large numbers are involved, it becomes a chance to make big mistakes that cost a lot of money.

Amy Laburda
So we talked about a lot of types of income. Have we done them all? Are there other types of income we should talk about?

Ben Sullivan 23:54
So we haven't really touched on income from businesses you operate, either as a sole proprietor or otherwise if you have a company that you're really, like, running. There are so many planning opportunities here that we could have a whole show on them, and that actually could be something that we talk about in season two: how to plan if you're a business owner. The most important considerations are to make sure you're keeping good records, to document all ordinary and necessary

business expenses, and to consider what types of retirement plans you can contribute to. When we were talking about tax evasion, this is also a place where it winds up coming up a lot, where people are like, “OK, so I can just buy a car in my LLC. And if I buy a car in my LLC, then it's an entire business expense. I can just deduct it.” And it's like, “Well, there are very specific rules if it is a ordinary and necessary process

to own a car and operate the car in your business.” So let's just talk about a contractor. If it's someone who's going to be painting houses, they need to have a truck that's going to be fully equipped. It probably has a sign on the side saying it's Amy Laburda Painting. And they'll be driving around town using that for business almost exclusively. Maybe they run some personal errands, but that's a legitimate business expense. But people hear that. They hear on TikTok:

Hey, just own your car through an LLC, and then you deduct everything. And it's like, that's not actually how it works. The people who are coming to me asking that, they're not really thinking about tax evasion, but it's like, “No, it's just not worth doing that. If you meet the rules, let's deduct it. But if you don't, it's not worth trying to save a little bit of money on taxes.”

Amy Laburda
Makes sense.

Ben Sullivan
Yeah, so beyond that, those business owners, and even some passive investments, you can wind up earning what's known as Qualified

Business Income, and that can get you a 20% deduction. But it really winds up that there's so many provisions in the tax code that high-income taxpayers often wind up not meeting the criteria to get that 20% deduction. Still worth thinking about when you're planning. And then unfortunately, there's also payroll taxes or self-employed taxes that apply to business income that you earn. And that can add another 15.3% on top of

ordinary tax rates. So really, like, when we're talking about the different types of income, you have ordinary income, you have qualified dividend income, capital gain income. So those are taxed at the lower rate. And then you have these other kinds of parts that play into certain types of ordinary income that might add additional tax or give you an additional deduction.

Amy Laburda 26:32
So it sounds like it adds complexity, but also potentially adds planning opportunities as well.

Ben Sullivan
Yeah, and if the circumstances are right, there might be ways to structure what you might think of as a side gig or a business, really into more of a formal business. It's not just a hobby. You can create a real business that's for-profit and then take deductions off of that gross income. Like I said before, you want to play within the rules. So you don't want to

create your hobby of just knitting on the side, and maybe you might sell a sweater for $15, $20. You don't then deduct a home office expense off of that. But if it's really more of a formal business venture that you can structure, hey, you might have a knitting room and you might be able to deduct that office space.

Amy Laburda 27:18
Also as a knitter, I can say if you are charging $20 for a sweater, you are undercharging your customer.

Ben Sullivan
Yeah, that is true.

Amy Laburda
A little free piece of knitting advice from the other side of the microphone. All right, so backing up a bit. On sort of the big picture, you mentioned the strategy of optimizing the timing of income and deductions. So how does someone actually do that? What does that mean?

Ben Sullivan
So each year people can have a different tax situation, depending on their income.

Maybe they realized a whole bunch of capital gains or received a big bonus, or maybe it was a less favorable year with capital losses and no bonus. If you're in a lower tax bracket than usual, you want to consider accelerating taxable income. You want to realize capital gains that you might have in your taxable account or maybe contribute to a Roth 401(k) rather than a traditional 401(k), because with the Roth 401(k), it's treated as taxable income

and it's essentially delaying your deduction. You'd also want to think about in that lower-income year delaying other deductions that you control the timing of. If you're with a year that has a higher tax bracket for you, and it's a good income year, this is the time that you want to delay income to the extent possible and maximize your deductions. You could consider funding more to charity during this year, so you get a bigger bang for your buck.

So really just like bringing it home. There might be a year where you're, like, in a 25% marginal tax bracket. And if you donate $100,000 to charity, you get a $25,000 deduction. But if it is a higher income year, you wind up getting a $37,000 deduction. So again, not getting into the politics, but it gets a little weird where it's like, “Hey, you made more money, so you get more of a benefit for your deductions in that year.” But really it's just saving that marginal tax bracket. So

in high-income years, accelerate your deductions. So you also want to think about this over several years and, really, your lifetime. You don't want to just think about making one-time moves, like I've been saying. It's … structure your life, and over time, in a tax-efficient manner. And you want to try to generate as much of your income at [as] low tax [a] rate as possible.

Amy Laburda
That makes a lot of sense. This is certainly not the first episode where we've talked about long-term thinking and sort of taking a bigger view.

Sounds like that makes a lot of sense for taxes and deductions, as well as pretty much everything else we've talked about at this point.

Ben Sullivan
Yeah. I think it is, like… That's really, like, if you can home in on one of the planning opportunities, like the timing of income. It really is just like — Let's just say you earn $10 million over your lifetime. If you can earn that in, well, if you can have that be taxed in lower tax brackets, it's worth substantially more than if you

get that all in one year and it's taxed at the highest brackets. So there's tax planning considerations for how the government changes the tax rules over time. So if the tax cuts expire, you might want to accelerate income before then. But really, to make it more like … something personal,

Amy Laburda

Ben Sullivan
you want to wind up where it's your personal tax rate, because your personal tax rate changes at different speeds and based on different factors than what the federal

tax rates do. So like all of that retirement planning, the whole purpose of that is: Push money away from the high-tax years into the low-income years, where conceivably it should be able to be taxed at a lower bracket when you pull it out of those retirement accounts.

Amy Laburda
Makes sense. So we’ve talked about timing pretty thoroughly.

Can we talk about, briefly, any credits or incentives? I think that's a thing that's on a lot of people's minds, especially since, as we talked about, the standard deduction is more in play for a lot of people. What are some of the credits people still want to maybe [be] aware of?

Ben Sullivan
So there are lots and they're specifically targeted on things that the government wants to encourage, and the rules change all of the time. But here are some of the ones that I think apply to a lot of people. Especially for people who are kind of getting older, thinking about maybe downsizing their home,

there's the exemption for the sale of your home. So you can exclude up to $250,000 on the sale of your primary residence, or $500,000 if you're a married couple. That's one that people always get confused on, whether it's like, “Hey, do I defer the gain? Do I pay it at a later time? Do I have to find an exchange property?” So there is such a thing as a 1031 Exchange, where you exchange one investment real estate property for another.

But really what we're talking about here is your primary home. And that's just a home sale exclusion. So exclude the $250,000 or $500,000. You just don't wind up paying tax on that ever. Another common example is the foreign tax credit. So you can claim a credit for income taxes paid to a foreign country. And this helps you make sure that you're not paying tax twice. If you're paying tax in Canada, and then you don't just pay tax again on

that same income in America. You wind up paying the Canadian tax or the American tax, whichever is higher. So you get a credit for what you paid to Canada, or any foreign country. So this applies to more people than you'd think, because mutual funds or even some ADRs, foreign stocks, you wind up paying foreign taxes on these types of income as well. And so on your 1099 that you receive, you'll see that there's a foreign tax that was paid.

So you want to just make sure that you enter that into your tax software and get the credit for that. So for people who have large investment portfolios, that can add up to a substantial amount of savings. Another example is the dependent care tax credit, or credits for qualifying expenses related to higher education. There's credits for making your home more energy efficient or for buying an electric car, that people love to take advantage of right now. And then there's lots of obscure credits that can help you save money.

Amy Laburda 33:26
So another good reason why it's helpful to have an expert tax preparer help you, just to make sure you're not overlooking any of these that maybe didn't apply to you the year before but do apply now, or have changed since the last time you filed your taxes.

Ben Sullivan

Amy Laburda
So is there anything else? It's obviously a huge topic, but did you have any other high-level points that you wanted to be sure to mention to our listeners?

Ben Sullivan
Yeah. We ended on some one-off tax credits that an expert might know about, but really, I want to bring it back

to the importance of making a long-term plan to structure your financial life in a way that legally minimizes taxes. And there’s some deep technical expertise that's required to do that, but that expertise is really only valuable if you have an open and ongoing dialogue with a trusted adviser, or whoever is planning your taxes, even if it's yourself. I can't come up with tax planning if I don't understand what your financial picture is, what the different moving parts are.

And like you really… We talked about investments, we talked about retirement plans. You can think about insurance. There are ways to tax plan with insurance. We don't really recommend that typically, but there are ways to do that. But estate planning, like a major thing that we haven't really touched on, is: When people pass away, there's a step-up in cost basis for all the assets that they're holding in their taxable accounts at that time. So that's like…

That's a super big planning opportunity that I love to plan around. We've talked about, “Hey, control when you recognize income. Try to minimize when you recognize income.” Let's just say you've invested in stocks in your taxable account, because that's what we were recommending earlier on. You're putting your bonds in your retirement accounts, tax-deferred retirement accounts, and you have stocks in your taxable accounts.

If you invested early on in your life, you maybe put $100,000 in, it's worth a million dollars later on in life, and you pass away. That $900,000 of appreciation, the step-up in cost basis eliminates the tax liability on that $900,000. So again, it's pulling everything together. It's not just investments. It's not just estate planning. It's not just federal income tax planning.

It's bringing them all together to look for those planning opportunities and to make the connections between the different parts of your financial life.

Amy Laburda
On a related note, I've heard some of our colleagues, and possibly you, say, “Don't let the tax tail wag the dog” when it comes to overall financial planning and making sure all these interlocking parts fit together nicely. What do you mean by that phrase when you say it, and why is it important to remember?

Ben Sullivan
Yeah, that's a good one.

We love to use that. “Please consult your tax adviser.” “Don't let the tax tail wag the dog.” “Past results are not predictive of future returns.” All of these are great sayings that we love to say here at Palisades Hudson, and also throughout the entire industry. I think sometimes people get caught up in tax planning and start to do things they wouldn't otherwise do. You need to understand that the tax consequences of a decision are really important.

But other things, such as the best financial outcome or the best outcome for your life, really, are more important than saving some money in taxes. Do you want to wait to sell an appreciated position because you don't want to pay a capital gains tax? Well, paying a tax might be better than losing a large amount of money if the stock goes down. So it's like, “Hey, don't make your investment decisions solely based on tax considerations. Let them be informed.”

If you're looking for a new car, you can save $7,500 if you buy a specific electric car. But is that the right car for your family? Does it work with your dynamics? Does it fit your needs? It's not the $7,500 that should motivate your decision there. It really points to the bigger issue that personal finance can be more about making the right decision for your personal situation than the optimal financial decision.

Amy Laburda
I think that's a great piece of advice to end on. So

thank you so much for coming on the show today, Ben. It was a pleasure to talk to you as always.

Ben Sullivan
Thanks, Amy. I tried to make taxes a little bit interesting and not so boring. And I think there's lots to be gained from understanding the tax consequences of your decisions.

Amy Laburda 37:52
“Something Personal” is a production of Palisades Hudson Financial Group, a financial planning and investment firm headquartered in South Florida. Our other offices are in Atlanta; Austin; the Portland, Oregon metropolitan area; and the New York City metro area. “Something Personal” is hosted by me, Amy Laburda. Our producers are Ali Elkin and Joseph Ranghelli. Joseph Ranghelli is also our director, editor and mixer. Our firm has written two books:

Looking Ahead: Life, Family, Wealth, and Business After 55 and The High Achiever's Guide to Wealth, which offers advice for younger professionals, entrepreneurs, athletes and performers. Both books are available on Amazon, in paperback and as e-books.