Tax planning can be an overwhelming process! You need to be aware of many rules and intricacies as you start planning and filing your taxes. Here are 6 tax planning tips to help minimize your tax liabilities and decrease your tax bill.
1) Understand your tax bracket.
You can’t plan for the future if you don’t know where you’re at today!
The US tax system is pretty straightforward: higher taxable incomes are subject to higher tax rates, and lower taxable incomes are subject to lower tax rates. Tax brackets display the tax rate you must pay on each portion of your taxable income.
There are currently 7 different federal income tax brackets with tax rates based on your income and tax filing status. For example, here’s the federal tax bracket for ‘Married Filing Jointly’:
- 10%: $0-$22,000
- 12%: $22,001-$89,450
- 22%: $89,451-$190,750
- 24%: $190,751-$364,200
- 32%: $364,201-$462,500
- 35%: $462,501-$693,750
- 37%: $693,751 or more
Tax Tip: People are often concerned that their taxes will be astronomical if they get bumped up into the next higher tax bracket. It’s important to remember that higher tax rates only affect the next dollar earned.
2) Know the difference between tax deductions versus tax credits
Tax deductions and tax credits play a major role when preparing your tax return. People often use these terms interchangeably, but there are some key differences you need to remember:
- Tax deductions: Tax deductions reduce your taxable income. There are two ways to claim deductions: standard deduction or itemized deductions. An example of a standard deduction is married couples filing a joint tax return. Itemizing your deductions involves listing off the expenses you want to deduct. Itemized deductions are state taxes paid (ie. income tax or property tax), mortgage interest, and charitable donations. Other deductions, often referred to as “top-line deductions”, like contributions to a traditional IRA, HSA, or self-employed health insurance premiums, are deductions used to calculate adjusted gross income (AGI).
- Tax credits: Tax credits reduce your tax bill dollar for dollar. This means that is you qualify for a $2,000 tax credit and you owe $4,000 in taxes, the credit would reduce your tax liability by $2,000. Common tax credits include child tax credit, adoption credit, home solar system credit, and earned income tax credit (EITC).
Both tax deductions and tax credits reduce your tax bill, but in different ways. Understanding the difference between these concepts will help you build a more effective tax planning strategy.
3) Avoid common tax filing mistakes.
The best way to minimize overall tax liability is to be as meticulous and organized as possible. Some of the most common filing mistakes are the simplest ones to correct, such as:
- Inputting the incorrect information (i.e. wrong filing status)
- Underreporting income or not reporting all income sources (i.e. side hustles or part time jobs)
- Claiming unsupported deductions and credits you don’t qualify for
- Missing filing and extension deadlines
- Mailing your return to the wrong address
Some of these may sound like a no-brainer, but maybe you received a promotion this year and it slipped your mind to update your tax information.
There are a lot of details that go into tax planning and filing, so it’s easy to make a mistake. Working with a tax professional can help you avoid errors like these.
4) To itemize or take the standard deduction…that is the question.
Now that you know what a tax deduction is, you need to understand when it’s the right time to itemize or take the standard deduction. Claiming the standard deduction is typically the easiest route because to itemize, you need to keep track of all your deductible expenses. Still, it’s not always the most tax-efficient one.
The 2023 standard deduction is:
- Single: $13,850
- Married filing jointly: $27,700
- Head of Household: $20,800
Itemizing your deductions instead of taking the standard deduction may make sense for you if:
- Your itemized deductions total more than the standard deduction you would receive
- Made charitable contributions to qualified charities
This is not an exhaustive list of deductions. Your tax professional will be able to guide you through the itemization process.
5) Take advantage of tax-efficient strategies
Tax deductions and credits are excellent ways to reduce your tax bill, but other tax planning strategies can also help you.
One of the best tax planning strategies is to maximize your HSA and retirement plan contributions. An HSA is a tax-exempt account that you can use to pay for medical expenses. The contributions are tax-deductible and the withdrawals are tax-free as long as you use the funds for medical expenses.
Contributing to a 401(k) or IRA can also help decrease your tax bill (and help you prepare for retirement). But be sure not to withdraw 401k or IRA money too soon as that can cause major penalties!
6) Above all, stay organized.
Tax planning can be an overwhelming process! Be sure to keep your records and stay organized. The IRS has 3 years to decide whether or not to audit your return, so it’s important to keep your records for at least that long. A tax-planning professional can also be really helpful with record-keeping so you don’t have to worry about keeping every scrap of paper!
Do you need a tax professional?
If you own few assets with minimal to no deductions, you may get by just fine with doing your taxes yourself! However, if you own a business, work in multiple states, or make significant charitable contributions, hiring a tax professional may be a good idea. You never know when you need a tax professional, so it’s important to start that relationship early!
*While a second mortgage is a home equity loan, it is technically only one type of home equity loan. For more information it’s best to talk to your lending institution of choice to get more details about the products that they offer.
This material is intended for informational purposes only and should not be construed as legal or tax advice. Information here is not intended to replace the advice of your investment advisor or financial advisor. This information is not an offer or a solicitation to buy or sell securities. This information may have been compiled from third-party sources and is believed to be reliable. All investing involves risk, including the loss of principal.