Tax season is upon us. Although filing taxes has been known to bring on stress, frustration, and even confusion, tax planning can alleviate these woes.
By arranging and analyzing your financial situation, you can minimize your tax liabilities and maximize your tax breaks.
Navigating the tax system in America can be a harrowing experience. But, with proper preparation, you can make the whole process go a lot smoother and even save money as well.
Interested in learning more? Continue reading, and we’ll walk you through the top tax planning strategies you should know about.
Understand Your Tax Bracket
You can try to stay informed about all the loopholes and tax breaks, but if it’s not relevant to your tax bracket, it’s not going to help you much.
The very first step to tax planning is knowing which federal tax bracket you’re in. Here in the United States, we have what’s known as a progressive tax system. This means that people with higher incomes will also pay higher tax rates.
There are seven income tax brackets to know: 10%, 12%, 22%, 24%, 32%, 35% and 37%. However, no matter the bracket you’re in, you most likely won’t end up paying that tax rate on your entire income.
There are two main reasons for this. First, you’re not taxed simply by multiplying your taxable income with your tax rate. The IRS splits your income into pieces and then taxes each piece at the corresponding rate.
Second, you’ll have the opportunity to subtract deductions from your income. This is why your salary isn’t the same as your taxable income.
Let’s look at an example:
Imagine you are a single filer who has a taxable income of $32,000. For the tax year 2019, that would put you in the 12% tax bracket. However, you don’t actually pay 12% on the entire $32,000.
Instead, for the first $9,700, you will pay 10%. Then you’ll pay 12% on the rest of the taxable income.
Know the Difference Between Tax Credits and Tax Deductions
Tax credits and tax deductions may be the most fun part of preparing your tax returns. Both will lower your tax bill. Although they work in different ways.
Knowing the difference between a tax credit and tax deduction will help you better implement your overall tax strategy.
A tax credit is when the government gives you a reduction in your tax bill, dollar-for-dollar. So a tax credit valued at $2,000 will lower your tax bill by $2,000.
A tax deduction is a specific expense that you had to pay that can be deducted from your taxable income. They reduce how much of your income can be taxed. These are extremely valuable, although tax deductions might not save you as much money as tax credits.
Know Which Tax Records to Keep
Although many people may be reluctant to do it, holding onto the documents that you use to complete your tax returns is extremely important. In general, the IRS has three years to decide if they’re going to audit your tax return. So you want to keep your documents for at least that many years.
Also, if you file a claim for a refund or credit after you filed a return, then you should hang onto those tax records. There are some circumstances where the IRS has a longer window of time to decide to audit you. Those circumstances include:
- Six years if you reported that your taxable income was at least 25% less than it actually was
- Seven years if you wrote off a loss from a worthless security
- Indefinitely if you didn’t file a tax return or you committed tax fraud
Make sure you keep your records organized and in a safe and private location.
Consider Putting Money in a 401(k) or IRA
Check with your employer to see if they offer a 401(k) plan that can give you a tax break on the money that you save for retirement. If you divert money from your paycheck directly to your 401(k), then that money can’t be taxed.
For the tax year 2019, you can put at most $19,000 a year into a 401(k) account. People aged 50 or older can funnel up to $25,000.
Even though employers usually sponsor these accounts, a person who is self-employed can also open a 401(k). And if your employer matches your contributions, you’ll get free money added to the account.
When it comes to IRAs, you have until the tax deadline in April to fund your IRA for the previous tax year. There are two types of IRAs: a traditional IRA and a Roth IRA.
The main difference between these two retirement account types is the tax advantage. If you open a traditional IRA account, then you only pay taxes when you take your money out of the account. With a Roth IRA, you pay taxes upfront but don’t have to pay taxes when you finally take the money out of the account.
The Importance of Knowing Top Tax Planning Strategies
Hopefully, after reading this article, you’ll feel like you have a better understanding of tax planning. Although filing your taxes may seem complicated at first, knowing what to look out for can make the whole process more enjoyable while also working in your favor.
Hiring a CPA is a great way to make sure that your taxes will be filed properly and with the best chance for saving the most money.
Need help with your taxes? Contact us today and see what we can do for you!