Being proactive can help maximize your benefits and minimize tax time surprises. A projection of your potential income tax can help you plan for the year ahead. We discuss six ways to plan for tax season throughout the year – so you’ll be in good shape when you file.
Figure Out Your Tax Bracket
Tax planning starts with projecting your income for the coming year and figuring out your tax bracket. There are seven federal income tax brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%. Click here to see what federal tax bracket you are in. Remember, no matter which bracket you’re in, you probably won’t pay that rate on your entire income.
Take Advantage of Tax Credits and Deductions
Tax deductions and credits reduce your tax bill, but they do so differently. Knowing the difference can help you plan to reduce your tax bill.
- Tax deductions are specific expenses you’ve incurred that you can subtract from your taxable income. They reduce how much of your income is subject to taxes.
- Tax credits give you a dollar-for-dollar reduction in your tax bill. For instance, a tax credit of $1,000 directly lowers your tax bill by $1,000.
Hundreds of possible deductions and credits are available, and there are rules about who can take them. Click here for a list of common tax deductions and credits.
Maximize Qualified Contributions
One of the easiest ways to reduce your income tax liability is to reduce your taxable income. You can defer your tax liability — or eliminate it — when you make qualifying contributions to investment accounts and plans. Remember, all 401(k) contributions must be made by December 31. You can contribute to IRAs and HSAs up to the tax deadline each year.
- Retirement accounts and plans. You can make tax-deductible contributions to a 401(k) plan, 403(b) plan or traditional IRA. The amount you can contribute yearly increases if you’re 50 and older.
- Health savings accounts (HSAs) give you the triple tax benefit of tax-deductible contributions, tax-free earnings, and tax-free withdrawals for qualified medical expenses.
- FSAs and DCFSAs. Flexible spending accounts (FSA) and Dependent Care FSAs (DCFSA) let you bypass taxes to save for healthcare costs and dependent care. Depending on the plan, you may need to use the funds in these accounts within the calendar year or shortly thereafter.
- 529 plans. A 529 plan allows you to contribute while enjoying tax-free earnings and withdrawals for approved educational expenses.
Plan Your Charitable Giving
Tax-deductible donations can reduce your taxable income, which is one tangible benefit of charitable giving. To claim these donations, you’ll need to itemize your deductions at tax time.
To make the most of your donations and increase your tax savings, you may want to use a “bunching” strategy. With bunching, you replace several years of smaller donations with a large donation in a single tax year to surpass the itemized deduction threshold. This allows you to benefit from itemizing your deductions and claiming the tax benefit of your contribution.
Consider Adjusting Your Tax Withholding
Your W-4 tells your employer how much tax to withhold from your paycheck. Here’s how to use the W-4 for tax planning. You probably filled out a W-4 when you started your job, but you can change your W-4 at any time. Download it from the IRS website, fill it out, and give it to your human resources or payroll team. You may also be able to adjust your W-4 directly through your employment portal if you have one.
- If you had a large tax bill when you filed your tax return in the past, you may want to increase your withholding. That could help you owe less (or nothing) next time you file.
- If you received a huge refund last year and would rather have that money in your paycheck throughout the year, do the opposite and reduce your withholding.
Set Up a System to Keep Tax Records
If you’re ever audited, keeping tax returns and the documents you used to complete them is critical. Typically, the IRS has three years to decide whether to audit your return, so keep your records for at least that long. Keep records longer in certain cases — if any of these circumstances apply, the IRS has a longer limit on auditing you: six years if you underreported your income by more than 25%; seven years if you wrote off the loss from a “worthless security”; indefinitely: if you committed tax fraud or you didn’t file a tax return. Click here for a list of tax documents to retain for your records.
Final Thoughts
Tackling your tax planning at the beginning of the year can help remain in control of your taxes for the coming year. Navigating the financial complexities of tax planning can be challenging. Contact us if you’re looking for help developing a comprehensive financial plan.
