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Welcome to the 47th edition of the Tech Financial Planning (TFP) newsletter.
Everyone feels like they are paying too much in taxes.
“We are getting killed in taxes.
We make $300k-$500k+ as a W2 household and we routinely pay 5 to 6 figures in taxes every year.
What can we do?”
Unfortunately, there’s no magic wand that you can waive to make your taxes go away.
Spoiler alert: sometimes it’s ok to bite the bullet and pay the taxes.
Because saving (or deferring) taxes almost always comes at some sort of cost.
It’s usually costs you one of two things
Access
Less money in your pocket today
Access
There are a lot of ways we can save or defer taxes in the right contexts.
But in order to do so, we probably lose access to our money:
401k - helps with taxes but you can’t touch it without penalty until retirement
IRA - same
529 - don’t touch it until the kid is in college
HSA - until there are qualified medical expenses or until retirement
Opportunity Zone - hold for 10+ years to get the full benefits
QSBS - must hold stock for 5 years
1031 exchange - now you have another property, but you don’t have the cash you would have received from selling
These can be great tools, and they can help you with your taxes, now or in the future.
But depending on the circumstances, they might not make sense because sometimes the most important thing is access to your money.
For example, if you are trying to buy a house in the next couple of years, I’d argue that all things being equal, access to your money is more important than tax savings.
Or if you are starting up a business and your income is going to be less predictable, you want to know you have money you can access.
Note: yes, there can be workarounds to some of these. You can take a 401k loan or certain withdrawals without a penalty. You can take out the basis of your Roth contributions. And so forth.
Less money in your pocket today
Paying less in taxes sounds great.
But there's one big caveat.
It usually means less money in your pocket today.
Here's what I mean:
contributing to your 401k? Less money in your pocket
contributing to a HSA or FSA? Yup, less money today
giving money to charity? You got it, less money today
buying a car for your business? Definitely less money today
putting money into a 529 for your kids? I think you get the point.
Don’t believe me?
Let’s run through the numbers.
Putting the maximum $22,500 into your 401k this year (2023 contribution year) will save you approximately $2,500 to $11,250 in taxes (depending on state and federal tax bracket).
But that’s still $11,250 (on the high end) less that you have today.
Or if you bought a $100k car for your business (or gave $100k away), the most you could probably save in taxes is $50,000.
Which isn’t great, because you are still out $50,000!
$100,000 purchase (or giving) - $50,000 tax savings = $50,000 less you have today.
So What Can You Do?
First, figure out your goals first, the tax savings second.
Following our examples from above:
If you aren’t charitably inclined, then why are you giving to charity?
If you don’t need a new car (or piece of equipment) for your business, then why are you buying one?
If you are going to make a tax saving move, make sure it fits in with your overall plan!
Second, the goal isn’t to pay the least amount in in taxes
I have several clients who have big, concentrated positions in a single stock.
And plus, many of them have big unrealized gains.
So understandably they are hesitant to sell because if they do, they will pay a lot in taxes.
But as many tech professionals learned last year, a big drop in your company’s stock prices will cost you a whole lot more than you would pay in taxes.
Like the person I talked to who had $6M in company stock at the start of 2022 but was worth less than $1M by the end of the year.
Putting It All Together
Another advisor wrote an awesome post about taxes for W2 employees, writing, “In the high-earning W2 Wild West, you hit a wall where the tax bite is unavoidable.
And all these fancy-sounding ideas will feel like using aspirin to treat the bubonic plague when it comes to reducing your tax bill.
There are very few hidden 'smoking guns', and if you're making a lot of money, you're going to pay a lot of taxes.
Period.
All we can do is focus on reducing taxes paid over the course of your lifetime and beyond” (emphasis added).
There’s only so much you can do to avoid or reduce taxes.
It will never feel good, and you’ll probably always feel like you’re paying too much.
You’ll probably want to throw up when you see how much of your pay went to taxes, even if you plan properly.
And that’s ok.
Because you can only control what you can control.
And frankly, it can often make more sense to pay the taxes than take the alternative.
But if you really hate taxes that much, I’ll make you an offer:
Give me the money (or the stock) and I’ll pay the taxes for you!
I know, very generous of me.
Obviously no one will actually take me up on this offer (although I wish they would), but hopefully you see the point.
People are willing to take drastic or risky action (or inaction) to not pay taxes.
Even when it doesn’t make sense.
Want Help?
If you want to work with a financial planner who can help you pay the least in taxes over your lifetime , schedule your free consultation.