What I'm doing (and not doing) to lower my taxes after a liquidity event

This year has been a doozy for my taxes.

Earlier this year, I sold stock and triggered a large capital gain - which is actually happy news (because “gains” mean I won!). But it also means taxes are coming.

To make it trickier, I moved states from California to Texas and switched jobs.

So from now until April 15, I have to sit on my hands and wait for a bill… Right?

Wrong. Enter: the end-of-year Tax Planning Review.

In this article, I'll share the steps I took to complete my own Year-end Tax Planning Review. All laid out in 3 steps (plus a bonus 4th step).

I'll share the specific strategies I am using to lower my taxes ✔. Along with other popular strategies I will not use ✖.

1. Know the Damage

I worked with my Tax Preparer to visualize what I'll owe for 2023. This is an estimate, or a 'Projection'.

To get started, I simply sent them everything related to my 2023 taxes I could think of. Just as if I was actually doing my taxes already. I sent most up-to-date paystubs, details on my stock sale, projected business income, and more.

My tax pro then organized the info so I could see my total income, how much I'd owe, and story behind it all.

2. Choose a (general) Tax Strategy

To grossly over-simplify, here is a general framework:

In short: any 'lumpy' tax years are ripe for opportunity.

The only real goal of tax planning is to smooth things out over multiple years.  In my case, it made sense to try to lower taxable income.

3. Decide which strategies make sense ✔

I wanted simple ways to lower my taxable income.

There are plenty of aggressive, red-flag strategies out there. I tend to avoid those.

Here are some strategies I am currently implementing to potentially lower my tax liability (not an exhaustive list):

• ✔ Tax Loss Harvesting - think of the Indiana Jones scene where he swaps the idol for something else of equal weight heavy. To execute, you sell your investment at a loss, then replace with something similar to a) capture the loss, and b) reinvest immediately to stay on track.

• ✔ 401(k) increases - we plan to save aggressively on a pre-tax basis in my wife's plan. Each pre-tax dollar saved lowers our taxable income.

• ✔ Solo 401(k) contributions - I can create my own 401(k) and put money into it on a pre-tax basis to offset any business income.

• ✔ Business expenses - I am slowly scanning my list of potential business investments and giving myself another month to decide if it makes sense. Spending a dollar to save a quarter on taxes is a poor plan. But if I planned on the cost already, I could expedite that spend today.

• ✔Health Savings Account - each dollar saved here is a tax deduction, similar to saving into pre-tax 401(k). We will max this by 12/31.

4. (Bonus) Decide which strategies do NOT make sense ✖

Just as important as using strategies that DO make sense. You need to identify the ones that do NOT make sense.

As mentioned, there is no shortage of internet personalities giving tips and tricks to lower taxes. But each one comes with degrees of risk.

Here are some popular strategies I am NOT using this year:

• ✖ Larger-than-normal Charitable Giving - a hugely popular strategy to lower taxes in big income years is to donate to Charity. You can even super-fund future years’ donations by opening a Donor Advised Fund. It’s a powerful way to get upfront tax benefits from something you were going to do anyways. But similar to business expenses, giving away extra money blindly for a tax deduction is a poor strategy. It only makes sense if you wanted to give it away. And in my case, at the level we give, we wouldn’t be able to write off the deductions anyways. This year it’s better for us to use the ‘Standard Deduction’. Charitable deductions are itemized on schedule A.

• ✖ Flex Spending Accounts - we don't have any of these. If we did, we'd have to spend it immediately before 12/31. FSA’s are typically use-it-or-lose-it accounts.

• ✖ IRA contributions - anyone can contribute to their IRA, but it doesn’t mean it deductible. The deduction is my goal, and our income is too high to deduct contributions this year.

• ✖ Roth IRA contributions - a Roth contribution is not a tax deduction. In any event, our income is too high to contribute to Roth IRAs this year. But I may explore the backdoor Roth strategy before April 15.

• ✖ Qualified Opportunity Zones (QOZs) - if you invest your stock sale proceeds into a QOZ and hold for many years, you can potentially defer ALL your capital gains. This is very attractive for folks going through liquidity events. But a QOZ is a real estate investment in an emerging neighborhood, which does not meet my current investing goals.

• ✖529 college savings - Some folks like to use high-income years to save money for their future children’s (or grandchildren’s) college goals. For tax planning, there is no upfront, Federal tax deduction by saving into a college 529 account. Some states may give you a state income deduction, though; Texas (my state) is not one of those.

Writing the Big Check

Last month, after mapping the damage and factoring in the strategies above, I could clearly see the damage (my expected tax bill). I then wrote the single, biggest check to the IRS I ever have.

And you know what? I feel great about it.

I won’t have any surprises come April 15. And I can sleep soundly knowing I managed my taxes the best I could.

Rinse-and-Repeat every 12-mo's ⏱ ✅

If you have any comments, questions, or thoughts, feel free to reply to me here.