It’s that time of year when we get bombarded with year-end tax planning tips. You’ll see them on the web, in the newspaper, on television, and just about everywhere you look. I read a top 10 list this morning that made me cringe! Why? Because the tips given didn’t consider the potential conflict with other personal and financial goals.
Here are the top 2 I see in just about every list:
#1 Buy Something This is the tip I hear most often that quite possibly has the most harmful consequences. I’ve heard too many business owners tell me they have to buy something before the end of the year for the tax write-off.
In the list I read this morning, it was recommended to buy equipment, a car or a house. I had to cringe! Is this list really about savings? While there may be tax savings available in all of these purchases, making a purchase of this size should never be based solely on the tax benefits.
Many business owners are given the advice to buy equipment before the end of the year because the equipment can be expensed under the Section 179 deduction.
Yes, the Section 179 deduction is a fantastic deduction but buying equipment for the sole reason of getting a tax deduction can result in bad tax planning that conflicts with business and financial goals.
It never makes sense to buy something for the sole purpose of getting a tax deduction!
Let’s say Pierre is in a 40% tax bracket. Pierre buys business equipment for $10,000 because he wants to lower his taxes. Indeed, Pierre saves $4,000 in taxes. But, remember, Pierre spent $10,000 to get this $4,000 savings.
If Pierre really didn’t need the equipment and purchased it solely for the tax savings, this is a terrible financial situation for Pierre. He would have been better off paying the taxes of $4,000 and not spending $10,000.
Now, there is a place for this type of planning. For example, if Pierre is planning on buying equipment in January, then moving his purchase up to December makes sense because he can enjoy his tax savings sooner.
Too many taxpayers hear the advice to buy equipment (or a car or a house) before the end of the year, get caught up in the tax savings and forget to consider if it makes sense in their big picture tax and wealth planning.
#2 Boost Your 401(k) Contributions Now, if you’ve been receiving my weekly report for awhile or have ever heard me speak, you know I am not a big fan of 401(k) contributions.
Taking my personal opinion of 401(k)s out of it, this advice still makes me cringe. What is most bothersome to me about this advice is that, once again, the tax savings are emphasized without a focus on the long-term financial implications.
Let’s say Pierre is able to put $10,000 in his 401(k) before the end of the year and it saves him $4,000. What is Pierre going to do with that money in his 401(k)? What kind of return will his money make? How does that return compare to what Pierre would have done with the money if he didn’t put it in his 401(k) and paid more in taxes?
Now, if Pierre has already decided that maximizing his 401(k) contribution each year is something that works in his big picture strategy, then this year-end reminder is very helpful.
Too many taxpayers get caught up in the year-end hype to maximize their 401(k) contributions (or other retirement plan contributions) without thinking through the impact on their overall financial goals. I know this because I talk to prospects on a regular basis who tell me they wish they would have done something different with their money rather than put it into their 401(k) – that in the long run, the tax savings were simply not worth it.
Year Round Tax Planning The best plan of attack is to identify tax saving strategies that work with your personal goals, your business goals and your financial goals for the long-term. This is the purpose of a tax strategy – it’s working all year-around, over several years, to continually reduce your taxes. Year-end tax planning is just one part of effective and efficient year round tax planning.