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!

“All income is taxable unless there is a specific law that states the particular type of income is not taxable,” said Christina Wenk, a senior tax manager with WNDE. She offered some basic rules you should know to help you file an accurate tax return:

• Taxable income.  Taxable income includes money you earn, like wages and tips. It also includes bartering, an exchange of property or services. The fair market value of property or services received is normally taxable.

Some types of income are not taxable except under certain conditions, including:

• Life insurance.  Proceeds paid to you upon the death of an insured person are usually not taxable. However, if you redeem a life insurance policy for cash, any amount you get that is more than the cost of the policy is taxable.
• Qualified scholarship.  In most cases, income from a scholarship is not taxable. This includes amounts used for certain costs, such as tuition and required books. On the other hand, amounts you use for room and board are taxable.
• Other income tax refunds.  State or local income tax refunds may be taxable. You should receive a Form 1099-G from the agency that paid you. They may have sent the form by mail or electronically. Contact them to find out how to get the form. Report any taxable refund you got even if you did not receive Form 1099-G.

Here are some items that are usually not taxable:

• Gifts and inheritances
• Child support payments
• Welfare benefits
• Damage awards for physical injury or sickness
• Cash rebates from a dealer or manufacturer for an item you buy
• Reimbursements for qualified adoption expenses

Christina also noted that some income items are taxable for federal purposes and not taxable for California purposes, such as state tax refunds being only taxable for federal purposes and only if you received a benefit from the deduction in a prior year.  Some income items are taxable for California purposes and not taxable for federal purposes.  For example, HSA contributions are deducted from wages when figuring your W2 taxable federal wages but HSA contributions are not allowed as a reduction to California W2 wages or as any kind of a deduction for California income tax purposes.  When preparing your California income tax return, you must add your HSA contributions to your federal wages to obtain your California wages.   You also have to include the interest or other earnings earned by your HSA account (not taxable for federal purposes) in California taxable income.  It is important to know what to include and not to include in your taxable income as it directly affects your tax liability.

The More You Know: Income Tax Edition

If you are uncertain whether an item of income is taxable or nontaxable, consult your WNDE tax advisor, Christina advised.   If you would like to read more on the subject of taxable and nontaxable income, see IRS Publication 525, “Taxable and Nontaxable Income.” Be sure to consider you are reading about federal tax law when reading this publication and that state laws may vary and often do.
Additionally, Christina offered “five interesting things you may not know about 2016 taxable vs. non-taxable income for individuals”:

• Some people who receive Social Security must pay federal income taxes on their benefits.  A portion of Social Security benefits is taxed if income above a “base amount” (based on filing status) is received in addition to Social Security Benefits (IRS Sec. 86).  However, no one pays federal income taxes on more than 85% of their Social Security benefits.  Social security benefits are not subject to California income tax.

• Gambling winnings are fully taxable for federal and California purposes and you must report them on your tax return.  For individuals who are not professional gamblers, gambling losses to the extent of gambling winnings are tax deductible as a miscellaneous itemized tax deduction and are not subject to the  2% floor of adjusted gross income.  However, individuals who are not professional gamblers do not receive a deduction for losses at all if they don’t itemize deductions.

• In most cases, prepaid income, such as compensation for future services and advanced commissions is included in your income in the year you receive it.  However, if you use an accrual method of accounting, you can defer prepaid income you receive for services to be performed before the end of the next tax year.

• Fringe benefits received from your employer are included in your income as compensation, unless you pay fair market value for them, or they are specifically excluded by law.

• Amounts you receive as workers’ compensation for a work injury or sickness are not taxable if they are paid under a workers’ compensation act or a statute like a workers’ compensation act.  However, retirement benefits you receive based on your length of service, age, or prior contributions to the plan are taxable even if you retired because of a work injury or sickness.

Each and every taxpayer has a set of fundamental rights they should be aware of when dealing with the IRS. These are your Taxpayer Bill of Rights. Explore your rights and our obligations to protect them on IRS.gov.
IRS YouTube Videos:

• Taxable and Nontaxable Income – English | Spanish | ASL

IRS Podcasts:

• Taxable and Nontaxable Income – English | Spanish