Did you know that, due to the fallout of the pandemic, 57% of Americans paid no federal income taxes? If only filing your taxes was that easy every year!
The last thing anyone wants to do on their own is file their taxes. With an ever-expanding list of rules and regulations, taxes can feel like an endless tidal wave. Luckily, there are some solutions for making your tax planning as easy as possible.
Read on to learn about six of the best tax planning strategies for beginners.
What is Tax Planning?
Tax planning is the process of analyzing and organizing an individual’s taxes to allow them to pay the least amount of taxes possible. There are dozens of ways to tax plan, and many of those plans can be combined together.
Tax planning is beneficial for everyone. Whether you’re tax planning for yourself, your family, or your business, there’s always a way to reduce tax debt.
Implementing Tax Planning Strategies
When considering a tax plan, it’s always important to consult the services of a tax professional. A tax professional is highly trained to understand the ins and outs of tax codes and will help you implement the right tax plans. With that being said, let’s take a look at some of the best tax planning strategies for beginners.
1) Understand Tax Credits and Tax Deductions
Tax credits and deductions reduce the amount of money you must pay if you owe money after calculating your taxes for a given year. There are hundreds of tax credit and deduction options available.
Tax credits directly reduce how much you owe in taxes, dollar-for-dollar. For example, a tax credit of $1,500 takes off $1,500 from your final tax payment.
Tax deductions reduce your amount of taxable income. Suppose you made $60,000 for the year, but your tax deductions total $7,500. This means your taxable income now becomes $52,500.
There are some caveats to both types of tax reduction, however.
Depending on your level of income, some tax credits will not result in a refund. If your income is lower than a nonrefundable tax credit that you qualified for, you will not receive the difference.
Tax deductions can either be standard or itemized deductions. While both deduction types are an option, only one can be chosen. Itemizing your deductions allows you to write-off things, like state and local taxes, mortgage interest, and charitable donations.
2) Understand Your Tax Bracket
One of the preliminary things to go over before taking advantage of a tax credit or reduction is understanding your tax bracket. Where you fall on the income scale determines how much you’ll owe back in taxes. Your tax bracket will also determine what sort of credits and deductions you’re entitled to.
Federal income taxes range from 10% to 37%, but your income is not taxed evenly. The United States follows a progressive tax system. This means that the higher your income, the higher the percentage of that income gets taxed.
3) File the Right Tax Form
Once you’ve understood your place on the federal tax hierarchy, it’s time to file the right tax form. There are several different kinds of tax forms; each has specific requirements to file.
1040 and 1040-SR forms determine how much you owe in taxes to the IRS. W-2 forms tell you how much income you have earned for the year and how much in taxes you have paid throughout the year. W-4 forms determine how an employer withholds much income tax on each of your paychecks.
Several more types of forms can be filed. You can learn about the rest of them here.
4) Keep a Record of Your Tax Records
Keeping your tax records won’t result in a direct reduction in your tax bill. But it can prevent you from paying any penalties due to an IRS audit. You can be audited for several reasons, so it’s best to be prepared if you end up on their radar.
Tax records are W-2 forms, 1099 forms, bank statements, invoices, receipts, and insurance records.
5) Consider a 529 Savings Account
If you wish for your kids to attend college, then a 529 college fund might be for you. With this plan, you can pay into a college fund for your children. States and educational institutions run 529 accounts, so they cannot be deducted from your federal taxes. However, any investment growth is not subject to federal taxes if the funds are used for qualified educational purposes.
6) Contribute to Your Retirement Plan
Do you have a 401k, Traditional IRA, or Roth IRA retirement account? If so, paying into either of the three can come with some tax savings.
Money deposited into a 401k account is not taxed, including employers matching your contribution. Contributions made to Traditional IRA accounts are considered non-taxable. However, any withdrawals before retirement are subject to taxation and potentially a penalty.
Contributions made to Roth IRA accounts do not have a direct tax benefit. However, withdrawals made during retirement are considered tax-free (because taxes are paid upfront and not itemized at the end of the year).
The limit for 401k accounts is up to $20,500 if you’re under the age of 50 and up to $27,000 if you’re over 50. Both IRA accounts have a contribution limit of $6,000 if you’re under age 50 and $7,000 if you’re 50 or older.
Tax Planning Doesn’t Have to be Complicated
While it may seem daunting at first, tax planning can actually be very simple. There are a variety of ways to plan based on your individual situation, so there is no need to ever feel lost. Use any of these tax planning strategies that suit your needs, and you will be good to go.
Are you interested in consulting for your business or organization? Contact us today to get started! We’ve got you covered.
Parker Business Consulting & Accounting, P.C. is a unique firm with more than a combined 75 years of experience in private industry, coupled with a strong background in public accounting. This combination enables us to provide valuable assistance based on direct experience with many of our clients’ same issues.