As insurance professionals, we are often asked to help clients with other components of their financial planning, including taxes at this time of the year. Maximizing after-tax income by taking advantage of all of the deductions, credits and deferrals provided in the Tax Code makes other financial goals — home ownership, college education, retirement funds — more accessible. When you’re asked for advice this tax season, keep the following tips in mind:
See also: 12 worst pieces of tax advice from financial planners
1. Always file a tax return. Filing taxes isn’t voluntary, no matter what some so-called “experts” might claim. If your clients received income over a certain amount depending upon their age and filing status, they have to pay tax on that income.
There is a difference between filing and paying income taxes, with potential criminal and civil penalties for failure to do either. Fortunately, when people don’t have the money to pay the tax when due, the IRS is generally willing to make arrangements to help them settle the account without undue hardship.
2. Remember that tax planning is a year-round exercise.
Tax planning is akin to maintaining real property: Proper diligence keeps repairs small problems, keeps damage minimal and ensures no major reconstruction is needed. Alert your clients that tax planning and actions to reduce taxes can be made throughout the entire year — January through December — to ensure they are paying only the taxes they owe, and not a penny more.
For clients who are self-employed, advise them to use the occasions of quarterly tax payments to review their assets and each asset’s impact on gross earnings. For example, they might want to sell securities to establish short-term losses or long-term gains, fund retirement plans or incur/defer medical expenses based upon balances in a flexible savings account.
3. Keep good records. Adequate documentation is essential for correct analysis and calculation of the taxes your clients owe. Throwing receipts into a desk drawer or relying upon memory is a sure way to under-count deductions and over-pay taxes.
Monthly statements from banks, brokers, mutual fund managers and others who provide financial information should be filed for easy retrieval and safely stored. Remember, the IRS can go back a minimum of three years in a tax audit, and even six years in some cases from the date a return is filed. Let your clients know that it’s prudent to not only maintain good records to file correctly, but to keep them for at least six years after the filing date in case of an audit.
4. Report all income. The IRS generally presumes that citizens want to pay the proper amount of tax on the income they received and recognizes that mistakes about the deductibility and amounts of a transaction can innocently occur. In those cases, it will recover the amount owed plus a modest penalty of interest.
However, failure to report income is a whole different situation, and can subject the non-filer to possible criminal charges for attempt to evade tax, willful evasion of tax, failure to report income, and/or failure to supply information. If one of your clients has unintentionally omitted income on a return for prior years, advise them to file an amended return using Form 1040-X as soon as possible.
Employers, financial institutions, and others who contract to provide services or products are required to give their clients a W2 Form or a 1099 Form. This information is also filed with the IRS and can be cross-checked to validate the information on each filer’s return.
5. Transfer income to a non-taxable status. There are a variety of legitimate ways to transform income that would be normally taxable to income that is nontaxable, provided it is spent for certain purposes. Flexible spending accounts (FSAs) can be used for health care, child care, even parking and transit expenses, while a health savings account (HSA) is limited to health care expenses alone. If your client is attending school or enrolled in special training, advise them to check if their employer has a qualified educational assistance program; if one is in place, the employer can pay up to $5,250 for tuition, fees, books and other supplies without the income being taxable to your client.