Tax planning doesn’t sound like a fun way to spend a few hours. But, when you know the benefits could save you a lot of money in the future—suddenly it’s worth looking into. Tax planning involves analyzing your financial situation from a tax perspective to ultimately minimize the tax you will have to pay in the future. It aims to align all elements of your financial plan, including investments, tax credits, deductions and deferrals, so that they work together in the most tax-efficient manner. Your accountant or a tax preparer will often pass along some common tax planning tips like the ones below after filing your returns. They are worth following up and asking a few questions if you need clarification on how to reduce your taxes.
Use Itemizing Over the Standard Deduction
Whether you choose to take the standard deduction or to itemize can make a huge difference in the amount of tax you end up paying. Itemizing is a lot more work, which is why many people avoid it and opt for the standard deduction. However, planning ahead and doing a few quick calculations can tell you which option is actually the most beneficial. Then, if you decide to itemize, you have all year to ensure that you have the right records in place to justify your deductions.
Learning About Available Deductions and Credits
There are a vast number of deductions and credits to help to reduce your taxable income. Many people are not aware of even half them, especially within the first few years of availability. Part of the tax planning process is to identify the deductions and credits that are applicable to your situation, ensuring that you meet the eligibility requirements. This is one important way that using the expertise of a professional tax preparer can pay off. He or she is more likely to be familiar with the full array of deductions and credits available, and understand the rules of how each one works.
Income Shelters and Other Investments
The money you invest in a 401(k) and traditional IRAs is not taxed, up to the annual limits. These investments reduce your taxes by diverting some of the income you earn now, to the future. In theory, when you begin withdrawing the money, your overall income will fall into a lower tax bracket than what applies to your situation today. There are also other savings tools that you can use to set money aside for education and healthcare. While the rules vary for each tool, they all have the same net effect of either deferring or reducing your taxable income.
Immediately after filing your tax return is the best time to start tax planning. You have a clear picture of where you stand at present, and have the rest of the year to plan and budget for next year and beyond. Tax planning encompasses many aspects of your finances beyond those mentioned above, so it is best to speak to a tax professional to fully understand the concepts and how they may apply to you.
