Why Tax Planning Matters
Taxes are inevitable. But smart tax planning can help reduce the burden.
Smart Tax Planning Frequently Increase Your Wealth
The core purpose of tax planning is to understand, and then strategically utilize, tax rules and rates to reduce your tax liabilities and increase after-tax income. Thoughtful planning can enable you to legally reduce or optimize your taxes in a number of ways: deferring taxes to future years, managing your tax brackets, increasing your deductions, excluding certain income/gains from taxation, and reducing the applicable tax rate. All else equal, this results in greater income and increased savings over both the short-term and long-run.
3-8% Lower Taxes is Reasonable; Reductions up to 37% Are Possible
They key question we frequently hear is "how much can tax optimization save me?" Like most things, it depends on your unique situation. But to try to be helpful (instead of using that "catch all" statement) -> at 30-40 Wealth Partners we've most frequently found that smart tax planning can help reduce a households tax bill by 3-8%. Less commonly, the impact of a smart tax strategy can be as high as 37%, or as low as 0% (e.g. a household was already optimized).
Tax Optimization in 3 Steps
Unfortunately, tax optimization is anything but easy. Tax rules and rates are complex and frequently changing. And for that reason we highly recommend consulting with an advisor to help you chart your path. At 30-40 Wealth Partners, we like to break the process down into 3 steps:
(1) Know What Types of Taxes Will Apply
Taxes can be weird. Certain steps you take with stock comp can trigger income taxes, while other steps-up capital gains. And when income is triggered, some types also require FICA taxes to be paid, while others don't.
The gist is, while "knowing the types of taxes that apply" sounds obvious, it's definitely more complicated in practice. We recommend that you first read/understand how taxation works for your stock comp holdings (i.e. ISO Taxation; NSO Taxation; RSU Taxation; ESPP Taxation), and then dive into the applicable rates for each of the 13 Types of Tax.
(2) Consider Applicable Tax Strategies
Once you know what taxes potentially apply to your holdings, the next steps is to understand what choices you have to optimize your taxes. While not attempting to overwhelm, there are more than 50 tax strategies that may apply, depending on what type(s) of stock comp you own and your circumstances.
To help you more quickly parse through the information (which we appreciate can be a lot), we've categorized each tax strategy into one of 9 categories, and written out the equivalent of a "1 page tear sheet" for each strategy detailing (more info here):
What is the tax strategy/overview
Tax details/background
Key benefits
Key considerations/flags
Strategy (when to consider it and when to avoid it)
Example(s)
(3) Select the Tax Strategy (or Strategies) Best for You
When you've made it this far -- sometimes the decision is relatively obvious and other times less so. The challenge with tax optimization is that its frequently the 3rd order focus, behind (1) Financial Planning Needs, and (2) Investment Risk Management.
That doesn't mean tax optimization isn't important; on the contrary it can have a very large impact on your wealth! Rather, like with most things detailed on this knowledge base, selecting the right tax optimization strategy is unique to you and your situation, and involves as much art as it does science.
But by this third step, you should be 50x more informed than most tech professionals, and thus able to make a much better decision. You know what taxes apply to your stock comp holdings, you've reviewed the menu of relevant tax strategies to consider (and the tax impact of each), and can weigh the pros/cons of a tax strategy against the investment risk and the needs of your financial plan!
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