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What Happens to Your Tax Liability With Proper Financial Planning?

When we think about managing our finances, it’s impossible to ignore the impact of taxes. Taxes are integral to our financial lives, affecting everything from our income and investments to estate planning and retirement. The decisions we make in our financial planning have direct consequences on our tax liability. So, what happens to your tax liability with proper financial planning?

As a Certified Tax Specialist™, tax planning is a large focus of my practice. The collaboration with my client families and their accountants can move us from reacting to what happened last year to proactively planning for this year. This comprehensive guide will explore the strategic financial planning opportunities I see regularly, which can profoundly influence your tax situation and, ultimately, your bottom line. You’re welcome to read on, or I can walk you through an abbreviated version in the video below.

The Basics of Tax Liability

What Is Tax Liability?

A clear understanding of tax liability is at the heart of effective tax planning. Tax liability represents the total amount of taxes an individual or entity owes to the government. This liability arises from various financial activities, including earning income, investing, and inheriting assets. Your tax liability is the net result of these financial interactions, and it’s essential to manage it effectively to prevent unnecessary tax burdens.

When it comes to tax liability, two fundamental concepts are key:

  1. Taxable Income: This refers to the portion of your earnings and financial gains that are subject to taxation. Your taxable income depends on various factors, including the source of income and available deductions and credits.
  2. Tax Rate: The rate at which your taxable income is taxed varies according to the tax laws where you live and the specific type of income or financial activity.

Types of Taxes

Taxes come in various forms, each serving a unique purpose in government revenue. Understanding these types is crucial for effective financial planning. Here are some of the most common types of taxes:

  1. Income Tax: The backbone of government revenue; this tax is based on your earnings, including wages, salaries, and investment income.
  2. Capital Gains Tax: Levied on the profits made from selling assets like stocks, real estate, and investments.
  3. Estate Tax: Taxes on the assets left behind after a person’s death can significantly impact your heirs’ inheritances. Oregon has a state estate tax for assets over $1,000,000/person. Federally, the estate tax exclusion is $12,920,000/person.
  4. Property Tax: Assessed on the value of real estate, including homes and land, and rates vary by location.
  5. Sales Tax: Applied to selling goods and services at the point of purchase, with rates varying depending on the item or service. It’s not an issue for Oregonians, but we certainly experience this when crossing our border states. In fact, we’re only 1/5 of the states without it.
  6. Excise Tax: A tax on specific goods, such as gasoline, alcohol, or tobacco.
  7. Gift Tax: Taxes are applied when you give assets or property to someone else, often with exceptions and limits. This typically kicks in only after significant gifts. Anything over $17,000/person/year is considered a non-taxable event. Amounts above that are counted toward your lifetime gift exclusion amount, which is capped at $12,920,000.
  8. Payroll Tax: This includes Social Security and Medicare taxes, typically withheld from an employee’s wages by their employer.

Tax Planning: The Foundation of Financial Strategy

The Role of Tax Planning

Tax planning is a crucial aspect of financial strategy involving making strategic decisions to minimize tax liability. Proper tax planning not only helps you keep more of your hard-earned money but also ensures you are in compliance with tax laws. It’s about optimizing your finances to reduce your tax burden legally.

The Impact of Tax Law Changes

Tax laws are not static; they change over time due to various factors, including shifts in political leadership, economic conditions, and evolving societal needs. It’s important to stay informed about these changes, as they can significantly impact your financial planning. Tax planning must be adaptable to navigate evolving tax landscapes.

A great example is the Tax Cuts and Jobs Act (TCJA) passed in 2017, which introduced substantial changes to the U.S. tax code, including significant tax cuts for individuals and corporations. However, many of the provisions within the TCJA are designed to sunset or expire after a certain period, particularly those affecting individual taxpayers. These sunsetting provisions included temporary tax rate reductions, various deductions, and credit changes.

One of the notable provisions was the individual income tax rate cuts, which are scheduled to revert to pre-TCJA levels after 2025. Additionally, certain deductions, such as the increased standard deduction and limitations on state and local tax deductions, are also slated to return to their previous levels.

The sunset provisions in the TCJA were part of the legislation’s budgetary constraints and were designed to manage the bill’s impact on the federal deficit. The debate about whether to extend or make some of these provisions permanent remains an ongoing discussion in Congress, and the future of these tax changes may be influenced by legislative decisions in the coming years.

Tax-Efficient Investing

Tax-Efficient Investment Strategies

Tax-efficient investment strategies are designed to minimize taxes on your investment gains. By making strategic choices in your investment portfolio, you can reduce capital gains tax, potentially keeping more of your investment returns. A few examples that I’m often working through with my client families include:

  1. Tax-Loss Harvesting: This strategy involves selling investments that have declined in value to offset gains in other investments. By realizing capital losses, you can reduce your overall tax liability. Be mindful of tax loss harvesting rules and restrictions.
  2. Long-Term Holding: If you hold investments for more than one year, you may qualify for long-term capital gains tax rates, which are typically lower than short-term rates. Consider your investment horizon when buying and selling assets.
  3. Tax-Efficient Funds: Some mutual funds and exchange-traded funds (ETFs) are structured to be more tax-efficient. They minimize capital gains distributions, reducing your tax liability. Look for funds with low turnover rates.
  4. Index Funds: Index funds tend to generate fewer capital gains because they buy and hold a static asset portfolio that tracks a specific index. This can result in fewer taxable events, making them a tax-efficient investment choice.
  5. Asset Location: Place tax-efficient investments in taxable accounts and tax-inefficient investments in tax-advantaged accounts. For example, stocks with lower dividend yields are often more tax-efficient in taxable accounts, while bonds and high-dividend stocks may be better placed in tax-advantaged accounts.

Tax-Advantaged Accounts

Tax-advantaged accounts, or tax-advantaged investment accounts, are specialized financial instruments designed to provide individuals with certain tax benefits and incentives. These accounts offer opportunities to reduce or defer taxes, making them an integral part of many individuals’ financial plans. Common examples include Individual Retirement Accounts (IRAs), 401(k)s, Health Savings Accounts (HSAs), and 529 college savings plans.

In tax-advantaged accounts, contributions may be tax-deductible (e.g., traditional IRAs and 401(k)s), and the investment earnings often grow tax-deferred or even tax-free (e.g., Roth IRAs). The specific tax advantages vary depending on the type of account and its purpose. These accounts are valuable tools for retirement planning, healthcare expenses, education funding, and other financial goals, helping individuals optimize their tax liabilities while saving for the future.

What Happens to Your Tax Liability With Proper Financial Planning? Income Tax Planning

Reducing Taxable Income While Working

Effective income tax planning involves minimizing your taxable income through legitimate means. Here are a few examples of the ways my clients who are still working are able to reduce their taxable income:

  1. Contribute to Tax-Advantaged Retirement Accounts: Maximize contributions to tax-advantaged retirement accounts like 401(k)s, IRAs, and 403(b)s. Contributions to these accounts are often tax-deductible, reducing your annual taxable income. In the case of a traditional 401(k) or IRA, your contributions grow tax-deferred until withdrawal in retirement.
  2. Health Savings Accounts (HSAs): If you have a high-deductible health plan, contribute to an HSA. Your contributions are tax-deductible, and withdrawals for qualified medical expenses are tax-free. This not only reduces your taxable income but also helps you save for healthcare expenses.
  3. FSA and HRA Contributions: Consider contributing to a Flexible Spending Account (FSA) or a Health Reimbursement Arrangement (HRA) offered by your employer. These pre-tax accounts can be used for eligible medical expenses, reducing your taxable income.
  4. Bunching Charitable Deductions: Bunching charitable deductions involves grouping multiple years’ worth of charitable contributions into a single tax year. By doing so, you may itemize deductions in that year and benefit from a higher total deduction. In alternate years, you can take the standard deduction. This strategy is particularly useful when you expect your itemized deductions to be close to the standard deduction threshold. With the higher standard deduction resulting from the Tax Cuts and Jobs Act (TCJA), many individuals find bunching charitable contributions advantageous.
  5. Employer-Sponsored Retirement Plans: Take full advantage of your employer’s retirement plan. Many employers offer matching contributions to your retirement accounts, effectively giving you free money while reducing your taxable income.
  6. Invest in Tax-Efficient Funds: Invest in tax-efficient mutual funds or exchange-traded funds (ETFs) that generate fewer capital gains distributions, minimizing your tax liability.
  7. Rental Property Deductions: If you own rental property, take advantage of deductions for expenses related to the property. These deductions can reduce your taxable income.

Deductions and Credits

Deductions and tax credits provide opportunities to reduce your tax liability. Deductions like mortgage interest or student loan interest can lower your taxable income, while tax credits directly reduce the taxes you owe, potentially providing substantial savings.

What Happens to Your Tax Liability With Proper Financial Planning? Retirement Planning

Tax-Advantaged Retirement Accounts

As discussed earlier, retirement planning often involves using tax-advantaged accounts like IRAs and 401(k)s. These accounts help you save for retirement and provide significant tax benefits while working. They also can create a headache in retirement when trying to mitigate your tax liability, particularly if you have other forms of fixed income, like a pension.

Retirement Income Planning

Planning for retirement income involves structuring your sources of income in a way that minimizes taxes. Proper planning can help you optimize your finances during retirement, ensuring you keep more of your hard-earned money. Here are some of the strategies I analyze for my client families:

  1. Roth Conversions: Convert a portion of your traditional retirement accounts, like a traditional IRA or 401(k), to Roth accounts. While you’ll pay taxes on the conversion, Roth accounts offer tax-free withdrawals in retirement, potentially reducing your taxable income during your retirement years. This is often a strategy fit for folks with a few years between retirement and claiming Social Security (e.g., their income is lower, meaning the conversions are less expensive).
  2. Strategic Withdrawals: Plan your retirement account withdrawals strategically. By carefully managing the timing and amounts of your withdrawals, you can minimize the tax impact. For example, you might withdraw from taxable accounts first to allow tax-advantaged accounts to grow tax-free.
  3. Social Security Timing: Delay claiming Social Security benefits if possible. By waiting to collect benefits until your full retirement age or even later, you can receive higher monthly payments, which may reduce the need to draw down other taxable retirement income sources.
  4. Tax-Efficient Investments: Hold tax-efficient investments in your taxable accounts. Investments like index funds, which generate fewer capital gains, can help minimize taxes on investment gains.
  5. Qualified Charitable Distributions (QCDs): If you’re at least 70½ years old and have required minimum distributions (RMDs) from retirement accounts, consider making charitable donations directly from your IRA through QCDs. These distributions can satisfy your RMDs without increasing your taxable income.
  6. Tax-Efficient Withdrawal Order: Plan the order in which you withdraw from your various retirement accounts. For example, you might start with taxable accounts and tax-deferred accounts before tapping into tax-free Roth accounts.
  7. Qualified Dividends and Capital Gains: In taxable accounts, hold investments that produce qualified dividends and long-term capital gains. These types of income typically receive favorable tax rates.

Skillful tax planning can not only reduce your tax liability, but also help you avoid Net Investment Income Tax, Medicare IRRMA surcharges, and other surprise taxes.

What Happens to Your Tax Liability With Proper Financial Planning? Navigating Other Life Changes

Marriage, Divorce, and Taxes

Marriage and divorce are pivotal life events with profound implications for your financial landscape, particularly concerning your tax liability. When you marry, you may encounter opportunities to combine finances and benefit from joint tax filing. However, you must also consider how spousal income affects your tax brackets, deductions, and credits. Conversely, divorce can entail the division of assets and alimony arrangements, which carry specific tax considerations. Understanding the intricacies of these life changes is essential for informed financial planning. It’s important to update your withholding status, reassess deductions, and potentially revise your investment and estate plans to align with your new marital status, ultimately optimizing your tax position in light of these significant life transitions.

Parenthood and Tax Benefits

Parenthood is a transformative life event that comes with the joy of raising children and the responsibility of providing for them. Fortunately, the tax code offers numerous benefits to assist parents in managing their financial obligations. Tax benefits, such as the Child Tax Credit, the Child and Dependent Care Credit, and the Earned Income Tax Credit (EITC), can significantly reduce parents’ tax liability. Additionally, 529 college savings plans provide a tax-advantaged way to save for a child’s education. By understanding these tax implications and making the most of available credits and deductions, parents can ease the financial burden of raising children and secure a more stable and prosperous future for their families.

Inheritance and Gifting

Inheritance and gifting represent pivotal aspects of wealth transfer and financial planning. Receiving an inheritance is a moment of both emotional significance and potential tax consequences. Understanding the tax rules surrounding inheritances, including estate taxes and stepped-up basis, can help you make informed decisions about managing and distributing inherited assets. Conversely, making gifts to loved ones, whether for celebrations, support, or estate planning, may also have tax implications. Gift tax rules dictate that individuals can gift a certain amount without incurring taxes, but exceeding these thresholds can lead to gift tax obligations. Awareness of these regulations and strategic planning can enable you to pass on assets and wealth efficiently, ensuring your heirs’ financial goals and well-being.

What Happens to Your Tax Liability With Proper Financial Planning? Estate and Gift Tax Planning

Federal Estate Tax

Estate tax planning is vital for those who want to ensure their heirs receive the maximum inheritance. Understanding how estate taxes work and what can be done to protect your assets from excessive taxes is important.

The federal estate tax is a tax imposed by the U.S. government on transferring a person’s assets and property at the time of their death. It applies to estates with a total value exceeding a specific threshold, known as the estate tax exemption. The federal estate tax exemption is $12.92 million per individual. Estates exceeding this threshold are subject to federal estate tax, which can reduce the value of the assets passed on to heirs.

Oregon Estate Tax

The Oregon estate tax is a state-level tax imposed on transferring a person’s assets and property at the time of their death within the state of Oregon. Like the federal estate tax, the Oregon estate tax applies to estates exceeding a certain threshold, and the specific exemption amount can vary. Oregon’s estate tax exemption is $1 million per person. Estates with a total value exceeding this threshold are subject to the Oregon estate tax, which can reduce the assets passed on to heirs.

Strategies for Estate Tax Mitigation

Estate tax mitigation strategies help safeguard your wealth and ensure it is distributed according to your wishes. Tools like trusts and gifting strategies can help you pass on your assets more efficiently. Here are three popular strategies that I’m often discussing with my client families and their estate planning attorneys:

  1. Tax Exclusion: One of the most straightforward ways to reduce estate taxes is to make gifts during your lifetime. You can gift up to $17,000 per person per year without incurring gift taxes. This amount is known as the annual gift tax exclusion. Gifting allows you to transfer assets to your heirs while reducing the overall value of your taxable estate.
  2. Use of Trusts: Various types of trusts, such as irrevocable life insurance trusts (ILITs) and grantor-retained annuity trusts (GRATs), can effectively reduce estate taxes. By placing assets into these trusts, you may remove them from your taxable estate while still maintaining some control or providing for beneficiaries. Trusts can be structured to align with your specific goals and needs.
  3. Marital Deduction: If you’re married, consider taking advantage of the marital deduction. This provision allows you to leave unlimited assets to your spouse without incurring estate tax, provided your spouse is a U.S. citizen. This can effectively double the estate tax exemption for married couples, as any unused portion of the exemption from the first spouse can be added to the surviving spouse’s exemption.

Tax Planning Tools and Resources

As you navigate the complex world of tax planning, various tools and resources are available to assist you. With the tax extension deadline freshly in the rearview, here are two checklists you can walk through as you review your 2022 tax return:


In conclusion, understanding tax liability in financial planning is essential for achieving your financial goals. Strategic financial planning, designed to minimize your tax liability, can lead to increased savings, greater wealth preservation, and peace of mind. By staying informed about tax laws, making tax-efficient choices, and adjusting your financial plan as needed, you can influence your bottom line in a positive and meaningful way.

Looking for a second set of eyes on your tax return? I offer free return reviews to offer high-level feedback on your tax picture. Shoot me an email if that sounds like something that would be helpful.