Tax planning is essential to lowering your tax bill. Meeting with a tax professional and reviewing your tax status before the end of the year allows you to develop tax strategies to take advantage of tax saving measures, before it’s too late. Although there are certain tax breaks you can take up until the last day you file taxes, like contributing to an Investment Retirement Account (IRA), most tax savings measures must be taken before the end of the tax year. For example, if you want to receive a tax deduction for a charitable contribution, you need to make the donation during the year you want to receive the deduction. That’s why it is important to implement a tax plan, before the tax year ends. The main benefits of tax planning are simple: decrease your income, maximize your tax deductions, and increase your tax credits.
You are probably thinking you need to make more money, not less. However, for tax purposes, the lower you can decrease your adjusted gross income (AGI), the less taxes you will have to pay. The IRS bases the tax rate you will have to pay and your taxable income on your adjusted gross income. Tax credits, discussed in more detail below, are based on your adjusted gross income as well, with higher income earners exempted from many tax credits.
Adjusted gross income is the total of all your income minus any adjustments like: student loan interest, health savings account contributions, and 401k contributions. Please note, you must have a high deductible health plan (HDHP) to qualify for a health savings account (HSA). The more you can expand your adjustments to your adjusted gross income, the more you can lower your income. Simply, the lower your income, the less taxes you have to pay.
The best way to lower your adjusted gross income for most people is to increase or maximize your contributions to your 401k, 403b, or other type of pre-tax retirement plan through work. It’s a win-win! You increase the amount you are paying yourself for retirement, while at the same time using funds to do it that would have otherwise been paid for taxes. Decreasing your adjusted gross income is an important benefit of tax planning.
The IRS uses your taxable income to determine the amount of taxes you owe. Your taxable income is determined by subtracting your tax deductions from your adjusted gross income. Deductions can be taken in one of two ways, either the standard deduction or itemized deduction. Starting with tax year 2018, the standard deduction increases to $12,000 for single and married filing separately filers, $18,000 for head of household filers, and $24,000 for married filing jointly and qualifying widow(er) filers. Taxpayers, who either do not qualify to take the standard deduction or can increase their tax savings by itemizing, take the itemized deduction. For help determining which is the best deduction to take, read the article here.
For taxpayers, who decide to or must take the itemized deduction, sorting through all the available deductions can be an overwhelming and a time consuming process. Save the receipts! Although starting in 2018 the miscellaneous deductions are eliminated under the New Tax Reform, many deductions remain. Some of the most common and largest deductions are: property taxes, mortgage interest, medical and dental expenses, and charitable donations. If taking the itemized deduction results in lowering your taxable income more than just taking the standard deduction or if you do not qualify to take the standard deduction because your spouse is filing separately and itemizing or some other reason, the hassle of keeping track of all your eligible deductions will be worth the frustration.
Whether you are taking the standard deduction or itemized deduction, a benefit of a well developed tax plan includes ways to maximize your tax deductions based on your individual circumstances.
Once you have determined your taxable income, it is time to look at your available tax credits. Unlike deductions, which reduce your taxable income, credits actually reduce the amount of tax you owe. Some credits, liked the Earned Income Tax Credit, can even result in a tax refund, if no taxes were paid, for example, for taxpayers who claim exempt from paying federal taxes or if the total tax owed has been reduced to zero by the Earned Income Tax Credit or by other means. Because tax credits reduce the amount of tax owed, if you need to choose between a tax deduction or tax credit, it usually is better to choose the tax credit, as you receive a much better tax savings.
Some of the most common tax credits include: Earned Income Tax Credit, Child and Dependent Care Credit, Adoption Credit, Child Tax Credit, and education credits. Two education credits, the Lifetime Learning Credit and American Opportunity Credit, are offered to help with education expenses, although taxpayers can elect to receive one, not both. It is an important benefit of any tax plan that it reviews strategies for increasing your tax credits based on your individual situation.
Filing taxes is a complicated process for many taxpayers and can feel overwhelming. This makes it even more important to implement a tax plan as a crucial part of your tax strategy. Tax planning is an extremely important part of a healthy financial plan and being proactive. Properly planning for filing your taxes can lead to saving hundreds, maybe even thousands, which can be used to increase your retirement savings and/or tax refund.
Contact the accounting and tax preparation professionals at Gudorf Tax Group to schedule an appointment for your tax planning session before the end of the year. They will review your individual tax situation and help you develop tax strategies that you can implement before it’s too late. Do not wait until you are filing your taxes to realize you could have saved hundreds or thousands, if you had only known sooner. Be prepared and educate yourself now; schedule that appointment.