Last-Minute Strategies To Lower Your Taxes

It’s that time of year when the sand has almost passed to the bottom of the hourglass. Most individual taxpayers are calendar-year filers which means that many opportunities to reduce your 2020 income tax bill will lapse after midnight on December 31, 2020. To help you achieve your goal of paying the least amount of income tax as possible, you may want to consider some simple, yet effective strategies

Taxes for personal property and real estate may be deducted on your individual income tax return if you elect to itemize for 2020. If you own property, you will have received a notice of taxes due on the property from the previous assessment by the County Assessor’s Office. You may wish to pay the full amount of taxes every other year to “bunch” up the deduction allowing you to accumulate deductible expenses in excess of the standard deduction. 

Income taxes paid to state and local governments are included in your itemized deductions. If you are self-employed, or receive income from sources that do not withhold taxes for you, you may be required to remit income taxes on a quarterly voucher. Typically, your fourth and final state income payment for 2020 is due on January 15, 2021. However, you may elect to remit payments in December to the state and local governments and claim the expense in 2020. The Tax Cuts and Jobs Act of 2017 limited the amount of state and local income taxes for deduction to $10,000.

Charitable contributions to qualified charities will increase your itemized deductions for 2020. Consider those charities that you typically support and be generous this year. As long as the charity is a qualified exempt organization and you remit payment before December 31, you should be allowed to include the deduction on your return. Don’t forget that you should request a receipt to document your charitable intent and the receipt of the payment by the organization.

Have you thought about cleaning out your closet or gifting your old car to a worthwhile charity? Good news! You may qualify for an in-kind donation. Additional rules and requirements must be followed to document the deduction but you will have helped a great cause and your closet or garage may look better, too.

Another easy method of lowering your tax bill is to defer any income that is possible. If you are self-employed, you may delay your billing for services until January, 2021 and, thereby, deferring payment to be earned income until the next tax year.

Remember in 2020 that personal exemptions are no longer allowed. Instead, a much larger standard deduction is availed to individuals and married filing joint taxpayers of $12,400 and $24,800, respectively. If you are a single parent with a child in your household, you may qualify for a little larger standard deduction of $18,650.

The key to tax reduction is to be proactive. Don’t procrastinate on this important task. By spending a few minutes planning, you may significantly reduce your tax bill for 2020. One statement we share with our clients is that “you should always seek to pay the least amount of income tax you legally owe”. 

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Gifts, Charitable Donations and Taxes

It is the time of year that we think of others. By “others” I am referring to our favorite charities, loved ones and the IRS. Sounds interesting to place the IRS in the same sentence as charities and love ones, doesn’t it? I offer that this particular government agency should always be a part of any discussion for gifts and donations.

Many people confuse the requirements that qualify charitable donations for deductibility purposes. A particular section of the Internal Revenue Code specifies the types of recipients (donees) that qualify for charitable deduction. Typically, a contribution to your local church may qualify for a charitable deduction in the year it was given. This means that you can generally contribute to your church’s building fund or other designated use funds for your church and claim the contribution on your individual income tax return for the year. Substantiation should be received from the charitable organization, in written form, that discloses the date of receipt of the gift, the amount received as a gift (unless it is other than a check or cash which would require the donor to assign a reasonable fair market value), the name and address of the charitable organization and a statement as to no services or goods given to the donor for the donation.

Unique for most taxpayers, that do not itemize deductions on their individual returns, the tax law changes signed by President Trump in March, 2020, allows for a deduction of $300 of charitable deductions for cash contributions to qualified charities. This deduction is claimed “above the line” which will lower the adjusted gross income of the filer resulting in lowered taxes owed. Highly recommend everyone to take advantage of this opportunity to help qualified charities during this difficult pandemic.

You may not realize but your Christmas gifts to loved ones actually fall within the requirements for reporting purposes to the IRS. You guessed it – gift taxes may apply! Talk about Scrooge, right? Consequently, the IRS wishes to know of any transfers of property for less than full value to another party to determine the amount of gift given to the party. Good news is that the IRS doesn’t require that you report the clothing, toys or other gifts given to your children if the total given for the year is less than $15,000 per donee for 2020. 

If you add up all of your gifts to Cousin Eddie, a reference to one of my favorite Christmas movies, and the amount is greater than $15,000 for 2020, you will need to consult with your tax advisor as to the filing of a gift tax return by April 15, 2021. Although a gift tax return may need to be filed, you will, generally, not remit any tax due to a unified gift and estate tax exemption of $11,580,000 per person. So, be generous this year!

Individuals are typically calendar-year taxpayers. This means that you lose some opportunities to lower your 2020 income taxes after December 31, 2020. It is critical that you review your current tax deductions for 2020 and accumulate those needed receipts to provide your tax preparer. Be proactive this year and contact your tax preparer now to book your appointment for receiving tax preparation services.

Lastly, remember those that have suffered during the pandemic. Families in our community may have little to enjoy the basic living needs of life much less Christmas with their loved ones. Disregard the IRS for a moment and let’s focus on our community. Reach out to families that may need a hand up, not a hand out, this Christmas Season. Put some joy in your life by giving to those in need.

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Do You Qualify For A Penalty-Free Distribution From Your IRA?

Many people possess an Individual Retirement Account (IRA) or employer plan that holds assets for their future financial security. Due to the substantial economic impact caused by the coronavirus, the IRS provided relief to individuals in the form of more liberalized distribution options for these types of accounts.

However, the misunderstanding of many citizens is that anyone under the age 59½ can take a distribution from their IRA without incurring the typical 10% additional tax (or penalty) for premature withdrawals. This misunderstanding could cost you a significant amount of money, including additional penalty and interest, if you fail to pay the correct amount of tax on the distribution.

To qualify for relief from the premature distribution penalty, you must be a “qualified” individual as defined in the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) enacted on March 27, 2020. A qualified individual is one that has met one of the following criteria:

  • You have been diagnosed with COVID-19 or SARS-CoV-2 by a test approved by the Centers for Disease Control and Prevention (CDC);
  • Your spouse or dependent is diagnosed with one of the above viruses;
  • You suffered adverse financial consequences as a result of being quarantined, furloughed, laid off or had work hours substantially reduced due to the pandemic;
  • You have been unable to work caused by a lack of childcare due to the pandemic; or
  • You suffered adverse financial consequences as a result of closing or reducing hours of a business that you own or operate due to the pandemic.

As an individual with evidence of one of the criteria applying to your situation, and the proof would be required of you, the 10% additional tax on early distribution would not apply. However, federal and state income taxes would apply in this instance. Relief is provided by the IRS in the payment of the income tax due on the distribution by reporting one-third of the income on your individual return over a three-year period beginning with 2020 or the year you receive your distribution. For example, if you requested and received a $12,000 distribution from your IRA, you may include $4,000 of the distribution in each of the next three tax returns filed beginning with your 2020 return. Of course, if you wish to report the entire distribution in the year of receipt, you may do so and pay the total amount of tax due.

Lastly, what happens if you decide to return or repay the distribution to your account? Additional relief is provided in this instance. If you have reported one-third of the distribution on your tax return for 2020 and 2021 but decide to return the funds to your IRA in 2022, you may file an amended income tax return for 2020 and 2021 to receive your refund of taxes paid in these years associated with the pandemic relief. The repayment of the funds would be treated as if they were repaid in a direct trustee-to-trustee transfer and no federal income tax would be due on the distribution.

In most cases, the perception of relief is far different than its actual purpose. Too many people hoped that a carte blanche relief approach would be offered and anyone, for any reason, could take a penalty-free distribution and that would be the end of the matter. Our tax code is not an area of law that is easily amended or comprehensive enough in its nature that revenue generation may be left out of the analysis.

Tax law is not simple to understand. To help your family and you make sense of these complex laws and regulations, seek out the advice of a CERTIFIED FINANCIAL PLANNER™ professional for an analysis and planning meeting to reduce your tax burden. Judge Learned Hand remarked, “Anyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that platform which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.” Now, that alone should help you enjoy a Happy Thanksgiving! 

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The Importance of Year-End Tax Planning

This is an optimal time to review your potential income tax liability for 2020. Most individual filers under U.S. jurisdiction are calendar-year, cash-basis taxpayers. This means that many of the options to lower your tax liability for 2020 are eliminated simply by the passage of the year. Just like Cinderella in the historic Disney movie of the same name, your world immediately changes for tax filing purposes at the stroke of midnight on December 31 each year.

A few simple strategies you should consider before the end of the year are presented in this article. First, review your withholding on your year-to-date pay stub to determine if adequate amounts have been withheld. This is a simple fix if you need additional withholding before the end of the year. Provide your employer or Human Resource Department a new Form W-4 to reflect your additional or less withholdings. Also, consider that you may experience a refund for federal taxes and owe a balance for state taxes. To mitigate this issue, provide your employer with a Form W-4 specific to each tax agency. This would be accomplished by conspicuously marking one of the Forms W-4 with “Oklahoma Only” or the name of your appropriate state at the bottom of the form below your signature. 

Another area of planning that is simple, yet considerably effective, is your deferral to your retirement plan, Health Savings Account or IRC Section 125 “Cafeteria Plan” to lower your current federal and Oklahoma taxable incomes for withholding purposes. Remember, most plans provide a matching component for your employer-retirement account that aids in the growth of your retirement assets without consideration of market activity. 

If you are utilizing a cafeteria plan for pre-tax qualified medical expenses, consider making an appointment with your medical providers to determine if you could schedule any procedures before the end of the year to mitigate the need for paying more deductible after the start of a new year. Many families have met, or are close to meeting, their insurance deductible by this time of year. Don’t allow this opportunity to pass if you are needing a medical procedure. Be proactive and seek out your medical providers’ attention to complete the procedure prior to December 31. The keys to success is to complete the procedure and the billing date of the procedure is properly noted in 2020.

Personal strategies such as increasing your tax deductible charitable donations may help you reduce your current year tax liabilities. Review your current level of itemized deductions and see if you can “bunch” your deductions every other year to allow you to itemize when you can exceed the standard deduction. By itemizing your deductions you may save additional state income taxes, depending upon your particular state’s law.

If you are wishing to reduce your estate by making inter vivos gifts to heirs, consider completing the gifts prior to yearend. You can gift each heir or donee $15,000 without the requirement of filing an annual gift tax return (Form 709). This is good news for both the donor and the donee. The donor will reduce their gross estate by the amount of the gift, provided the person lives for three years beyond the date of the gift, and the recipient owes no tax on the receipt of the gift. This is a win/win!

What happens if someone gifts you $1,000,000? Do you owe taxes on the gift? No! Isn’t the U.S. Tax Code a beautiful thing? As a recipient of a gift, of any size, where the intent of the donor was to transfer property or cash to you, without the requirement for reciprocal value or services, you will not owe income tax on the gift. I know what you’re thinking. You may have found a reason to eat Thanksgiving Dinner with your estranged, but rich, Uncle Charlie to discuss this important strategy for lowering his estate. Enjoy the giblet gravy!

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Clarifying Tax Law Confusion

Last month, President Trump issued an executive order to provide employees relief from withholding taxes. The result is additional take-home pay for the employee. This article focuses on the mechanics and results of this order. I will also opine on the impact of such order to the solvency of the Social Security Benefit Program which, as stated in my previous article, remains marginally funded through 2035.

We all wish to create greater amounts of cash flow for our living expenses but at what price does this wish come true? For example, if you are currently employed, you are contributing to your future through a withholding program titled “Federal Insurance Contributions Act” abbreviated as FICA. Two components make up the FICA portion of your paycheck withholding. The first component is the Social Security Tax, also called the Old-Age, Survivors and Disability Insurance (OASDI) Tax, at a rate of 6.2% of your gross wages to a maximum wage limit of $137,700.

The second component of the FICA is the Medicare Tax at the rate of 1.45%. This tax is applied to all wages paid to an employee. Unlike the Social Security Tax, the Medicare Tax has no annual wage limit. These withheld funds are committed, by the U.S Government, to your future for purposes of assisting with lifestyle expense. 

The president’s order requires employers to discontinue withholding the 6.2% FICA from employees’ paychecks. However, the employer continues to be responsible for the matching funds at a rate of 6.2%. To further complicate the application of the order, employees with bi-weekly income of greater than $4,000 do not qualify for the deferral of the 6.2% Social Security Tax. Based on a weekly payroll of $2,000, employees earning less than $104,000 in annual wages will be eligible for the deferral and will take home more net pay.

As with any tax benefit, the applicable period for the deferral of Social Security Tax for eligible employees is September 1 through December 31, 2020. The desire of the Executive Branch of our government is to develop a law that will allow the deferred balance of Social Security Tax to be eliminated instead of repaid by the employee.

To remedy the confusion on which party, employer or employee, pays the deferred Social Security Tax, the IRS issued on August 28, 2020, Notice 2020-65. The notice directs employers to remit the deferred Social Security Taxes ratably over the period January 1, 2021 through April 30, 2021. Failure to remit the taxes deferred from 2020 will subject the employer to interest and penalties.

One could argue the additional cash flow required to pay both employee and employer shares of the Social Security Tax places a burden on the employer. What will be the tax deduction allowed the employer if both shares of the tax are paid by the employer? Tax policy would dictate the fairness of allowing the employer the deduction since the economic impact is actually borne by the employer. However, tax policy in the United States is not based on equality but rather revenue generation. Who knows what will happen until we receive additional guidance from the Treasury Department?

Until then, keep smiling, enjoy your extra cash and I’ll see you on the golf course! 

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Selling the Farm? Think About This Tax-Saving Election!

You worked your entire life and a significant amount of your family’s wealth is tied to the family farm. This scenario is experienced by many families in the U.S. How do you obtain your value from the land and pay the least amount of income tax? There is a way.

The income tax laws, referred to as the Internal Revenue Code in the United States, provides for families to retire from the farm without paying current income taxes on the transaction. As you can imagine, there are a few caveats and requirements to performing such a transaction. This type of land transfer is known as a “like-kind exchange”. In recent years the regulations governing this type of transaction have been refined to allow property held for productive use or investment (i.e., the farmland) to be exchanged with other investment property to defer the tax on the potential gain in the land.

Think about this approach. Mr. Jones has a farm which consists of 640 acres of pastureland. He purchased the land 40 years ago. His basis in the land is $100 per acre or $64,000 for the total parcel. However, Mr. Jones is ready to retire and decides he wants to sell the property. Today, the land is worth $1,000 per acre or $640,000 for the total parcel. Mr. Jones visits his CPA to discuss his decision to retire and sell his land. The good news is that Mr. Jones is retiring. The bad news is that his federal tax bill on the sale of the could be as much $128,000! 

To defer the tax bill to its latest due date, Mr. Jones’ CPA informs him of a structure that allows Mr. Jones to exchange his farm land for other land that is held for investment. Perhaps Mr. Jones would desire to own rental properties that would generate cash flow to supplement his retirement?

This area of law is very specific but can provide significant benefit to taxpayers. Two important timelines are required to be met to treat the property received in the exchange as “like-kind” property: 1) The property to be received must be identified within 45 days after the taxpayer’s property is relinquished in the exchange; 2) The property transaction shall be closed within 180 days after the relinquished property is transferred to the other party.

Additional parties are involved in this type of transaction. A qualified intermediary is utilized to transfer the deeds, hold the deposits and to execute the transaction on behalf of the two exchange parties.

Before you simply decide to sell your farm, think about other opportunities to mitigate the tax bill. You will be glad you did. 

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How Long to Keep Tax Records?

If you are like most individuals, you have a drawer in your home or a box in the garage that contains all of your tax returns and supporting information from 1987. It is the sacred box of “all things to defend myself from the IRS”. Today, I am providing you some guidance that will help you clean out that drawer or box as well as relieve your mind from future inquires of taxing agencies.

There is no other word that strikes fear in the hearts of citizens worse than “Internal Revenue Service”. You go to mailbox and open it with a smile hoping that Ed McMahon has sent you the winning ticket to a sweepstakes only to find an ominous envelope from the IRS. Before opening the envelope, your mind races through a myriad of circumstances and outcomes. Survival instincts fire in your brain that you should seek a lawyer or CPA, transfer assets to other relatives or some other ridiculous plan to counter the attack by this federal agency.

Would you believe that most correspondence from the IRS is clerical in nature? The complicated system of revenue collection in the United States does not process without mistakes. A few years ago, one of our new clients came to the office, looking white as a sheet, and holding a rather large, white envelope. Her introduction omitted pleasantries and she immediately initiated her case of fearing the IRS and now “I will lose my house!” After speaking with her for a few minutes, providing a nice cold drink of water, and opening the envelope to read its contents, we disclosed some good news to her. She didn’t owe the government any money, she was actually receiving a refund. She looked at me with her eyes as big as silver dollars and exclaimed, “What?” Her previous tax returns, prepared by someone else, had omitted one of her estimated tax payments and she was receiving a refund of almost $21,000. 

The moral of this story is that many citizens do not understand the role, authority and power of the IRS. This agency is one of the most powerful of our government. However, in my 33-year career of interacting with the IRS, I have experienced very few instances where I was treated unfairly or unprofessionally.

Maintaining proper and complete records of your financial transactions reported on your tax returns is critical to good outcomes. The statute of limitations for most individual income tax returns is three years from the date you filed your return or two years from the date you paid the tax owed. This means that any of your individual income tax return forms can be destroyed or scanned to electronic storage. You should keep all records to document income, expenses, gains and losses from the three years’ of returns so that you may properly defend your tax returns should you be selected for audit. Wow! That sounds like a sinister word – audit.

Certain documents should be retained indefinitely such as property deeds, birth certificates, gift tax transactions, stock certificates, bonds, and marriage licenses. Most of these documents can be reclaimed but the process is rather time consuming.

The key to a pleasant and happy life is to understand the role government plays in our lives. Too often myths and speculation rule our minds when the actual facts are much less menacing. If you receive a notice from any taxing agency, contact your CPA or tax preparer to determine the appropriate response. As citizens, you have appeals rights, amendment capabilities and other actions you can take to mitigate or eliminate your tax matter.

If you have a question about filing your individual income tax returns, click this link for information that may be helpful. Until next week, stay safe and well.

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Simplifying Tax Filing Status

Every year taxpayers that experience marital change, during the year, are confused about their proper filing status. The Internal Revenue Code (IRC) provides guidance on the qualifications of each of the individual taxpayer filing statuses.

Confusion arises when there has been a marriage or divorce during the tax year. Dependents are no longer allowed as a personal exemption but are utilized for certain credits of the tax code. Who is a dependent for tax filing purposes? What status do I use if my spouse dies during the tax year? How long can I claim a certain filing status? To say the IRC is complex is to say the Mona Lisa is simply another painting! 

The basic guidelines for filing status for an unmarried individual will be one of the following: Single or Head of Household. You are considered unmarried for the whole year if, on the last day of the tax year, you are either unmarried or legally separated from your spouse under a divorce decree. State law, not the IRS, governs whether you are married or legally separated under a divorce decree.

Some nuances in the IRC, and its regulations, regarding divorced taxpayers create additional challenges to those individuals attempting to avoid taxation through the legal means of divorce. For example, if you obtain a divorce for the sole purpose of filing tax returns as unmarried individuals, and at the time of divorce you intend to remarry and do so in the next tax year, you and your spouse must file as married individuals for both tax years.

If you are considered unmarried on the last day of the year, paid more than half the cost of maintaining a home and a qualified child lived with you more than half of the tax year, you may file as Head of Household. This filing status will allow a greater standard deduction than that available to an unmarried taxpayer.

Life sometimes creates difficulty for us. For example, if you were married for only one day of the tax year and your spouse dies, you may continue to file as a Married Filing Joint taxpayer for the year. Further, if your spouse dies in 2019, you may file as a joint tax filer for 2019 and use qualified widow(er) status for the succeeding two years. To claim qualified widow(er) filing status you must have a dependent, child or stepchild, you can claim during the tax year.

Don’t allow life to cause you confusion and distress. Seek out a Certified Financial Planner™ practitioner and CPA that can help guide you through the maze of laws and regulations. You will be glad you did! 

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Want Less Stress at Tax Time? Do This!

Are you one of those people who lose sleep at night, suffer anxiety and, generally, feel miserable when it is time to file your individual income tax returns? One of the best methods of experiencing a better way of life is to take charge of the activity. Don’t allow yourself to procrastinate on this important task and create stress in your life.

By performing the following three steps, you will find the upcoming filing season to be less of a burden and, dare I say, even enjoyable. First, start collecting your tax reporting information before January 1, 2020. Gather all receipts, bank statements, investment statements, paystubs, etc. that may be required for the complete and accurate filing of your returns. Organize the expense receipts by topic and total the topics to make it easier for you (or your paid preparer) to complete your filings. We recommend performing this same procedure each month. You will find the process takes very little time and saves a tremendous amount of stress when January rolls around.

The second step is to review your investment statements to see if any of your positions should be sold to capture losses and offset your investment gains. This is the process for accounts that are not IRAs known as nonqualified accounts. The act of reviewing your accounts to perform this task is known as tax harvesting. Your goal is to simply sell enough positions with losses to allow you to sell an equal amount of positions with gains and no tax effect. As a side note, this would be a great time of year to review your retirement plans and other holdings with a Certified Financial Planner practitioner to confirm you are on track with your goals.

This third step is very helpful to reduce your taxable income. Review your itemized deductions for 2019 thus far. If you are needing additional deductions, you should consider charitable contributions, payment of your state income tax estimated tax payment, donation of non-cash goods to a qualified charity and other means of accelerating deductions into 2019. With the changes in standard deduction because of the Tax Cuts and Jobs Act of 2017, it may be beneficial to “bunch” deductions every other year to allow yourself a larger deduction on your returns. 

As a bonus, contact your tax preparer and inform them that you are bringing your information to them earlier this tax season. If you want to make them smile, tell them you have burned the paper sack you usually bring and will be dropping off an organized list of income, deductions and other pertinent information.

For additional, free information about preparing for your tax preparation appointment, go to the Compass Capital Management Website. You will find a wealth of information to help you navigate life!

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Time is Running Out

As a calendar-year, cash-basis taxpayer, you will have fewer opportunities to reduce your 2019 income tax burden once the calendar rolls over to 2020. By taking a few simple steps today, you will see a better result when you file your income tax return in April, 2020.

If you participate in a Flexible Spending Health Plan, referred to as a “cafeteria plan”, through your employer, it is critical that you utilize (spend) your elected deferral amount for 2019. The IRS has liberalized the rules regarding the ability to claim qualified medical expenses and you may carry over a small portion of your elected deferral amount to a following year. Discuss your options with your company’s Human Resource Officer for your particular plan.

Consider paying your total advalorem tax assessment in full prior to December 31, 2019. The Tax Cuts and Jobs Act of 2017 increased the amount of standard deductions to such levels that most individuals will not incur sufficient qualified itemized deductions to file a Schedule A – Itemized Deductions Form – with their returns. Analyze your current level of qualified deductions to determine if you exceed your standard deduction of $12,200 for individuals or $24,400 for married filing joint taxpayers. A lowered state tax may be an added incentive to itemize deductions on your federal return. 

What if you could take a deduction on your tax return for something that doesn’t require your current cash? You may receive an increased benefit by donating appreciated stocks to qualified charities. The process requires that a donor (you) physically donate the certificate of the shares to the charity instead of selling the stock and donating the proceeds. You will receive a tax deduction based on the fair market value of the stock on the date of the donation (transfer). Since the charity is generally exempt from federal and state income taxes, the charity will sell the stock and receive the much needed cash it desires to run its programs. For example, you may have basis in the stock of $1,000 and the fair market value has risen to $10,000. Your charitable deduction is $10,000 (your deduction is limited to 30% of your adjusted gross income). You do not realize the $9,000 capital gain that would be taxed if you sold the stock. It is a win-win situation!

Lastly, review any employee benefit elections for 2020 that are required this month. Most employer-provided retirement plans utilize an enrollment period in November or December of the current year to elect the amount of contributions for the next year. One of the most effective and efficient tax deductions is the contribution to your retirement. Maximizing this election will save federal and state income taxes as well as receives growth via the employer matching contribution. We advise clients to defer at least the matching percentage provided by the employer so that you literally “double” your money notwithstanding market conditions.

Be proactive in your finances and retain more discretionary income for your family. If you want additional information on the above tax strategies and other financial planning methods to help your family reach its goals, go to the Compass Capital Management Website. You will find a wealth of information to help you navigate life!

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