• Malissa Marshall, CFP®, EA

The Ghost of Tax Returns Past 😱 - Gaining Perspective

Updated: Jul 29


As you may have noticed, it's become that darkening time of year again when we are visited by the ghost of tax returns past, which challenges us to reflect on our mistakes before making firm resolutions to do better in the New Year. Despite how scary they may be, taxes are really the shadow aspect of financial planning, since they underlie almost all financial decisions and can often contribute quite materially to their success (or failure). In that spirit, it's a great time to talk about year-end tax planning, and why it is such a key component for building and maintaining a robust financial plan. Unfortunately, November and December span multiple major holidays (including the bookends of Halloween and New Year’s Day), and it is therefore an incredibly busy time for working families. Nonetheless, it's still important to take this one last opportunity to step back and consider the bigger financial picture, so that you have the chance to make decisions that could impact your happiness and sense of well-being come spring, and potentially for years to come.

Perspective I had the good fortune to take a Saturday off just after the end of tax season and used it to hike up the mountain behind my home to enjoy the view above. It‘s always helpful to take a step back and look at things with fresh eyes. Toward that end, how about pulling out your 2018 tax returns for a moment and taking a look? Probably the last time you saw them was when your accountant handed you a thick folder, told you where to sign and how many checks to write and for how much. Were you happy then? Here's your chance for a fresh start. The most obvious issue in reviewing last year’s tax returns is the bottom line: did you owe, or were you giving the government an interest-free loan? If you owed a lot, you likely paid an underpayment penalty (5-6%); if you had a balance due after April 15th, you added a late payment penalty (6%), interest (6%), and - if you forgot to file an extension - an additional 4.5% per month for late filing. If you are an employee and faced a shortfall, you should submit a new Form W-4 to your employer to increase your withholding. If you're self-employed, or a business owner or partner, you need to make quarterly estimated tax payments. This is an even more complicated undertaking because unlike an employee, your income is often variable throughout the year and difficult to predict year-to-year. Let me know if you need help with this. Of course, one other income source causes frequent headaches at tax time - namely, investment income. If you receive a lot of interest, dividends, and capital gains, you should either make quarterly estimated tax payments or adjust your withholding accordingly. But there are other ways to mitigate the tax bite. Earn a lot of interest? Consider muni bonds, which are not taxable by the IRS or possibly your state. Earn a lot of dividends? Make sure they're qualified, which means they're eligible for lower capital gains tax treatment - taxed at a maximum rate of 23.8% vs. 37% for other types of income. Last but not least: did you have a lot of capital gains? This one is more complicated, with more pieces to unpack. If the gains were short-term (meaning you held the stock for less than a year before selling it), you are again paying taxes at higher ordinary income tax rates (up to 40.8%), rather than at the preferential long-term capital gains rates (max 23.8%). Are you taking advantage of tax-loss harvesting? In which you purposefully sell stocks that have decreased in value in order to offset capital gains. Is your capital gain schedule multiple pages long? Excessive trading increases costs in a portfolio and can depress returns, therefore making it more difficult to achieve long-term growth. One of Warren Buffett's most important lessons is to invest for the long term for these very reasons. Of course, if you've gotten this far with your tax review, why stop there? Take a few more moments to reflect on your investment portfolios. Are they properly diversified, and is the risk profile properly aligned with your time horizon, risk tolerance and risk capacity? Have you done a deeper dive to consider asset location optimization? Don't hesitate to reach out if you could use some help to manage your investment income more effectively. One final concern I frequently have when reviewing income tax returns: there's no interest at all. One of the foundational steps of a solid financial plan is to have an emergency fund with at least 3-6 months' worth of expenses set aside, perhaps more, depending on your situation. Interest rates are historically low and heading lower, but the purpose of those funds is so that you will not need to tap into credit cards, home equity loans or retirement funds should an unforeseen expense arise. In short, reviewing a tax return says a lot about your choices - intentional or not. Fortunately, you still have two months to make some changes so that you can more closely align your finances with your values and long-term goals. The next issue of the newsletter will address "the ghost of tax returns present" - namely, how to use taxes to your advantage, which should help you gain the confidence to achieve your financial goals.

If you are interested in year-end planning and better understanding how these various choices fit into your overall financial picture, check out my website for additional details about how we might be able to work together, or - if you are ready - go ahead and sign up for a free initial consultation. Otherwise, I’d be happy to hear from you if you have any questions you'd like me to address, if you have any feedback you'd like to share, or if you just want to say hello!

PS. It should go without saying that this information is offered for educational purposes only, and that you should speak with a qualified professional about your particular circumstances before making tax and investment choices in order to further your goals.

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