Top 3 Tax Planning Strategies

Thursday, April 2, 2020, 6:00 PM | Leave Comment

Tax planning should be an essential part of your financial life. By doing your research and staying organized, your personal tax situation can be leveraged so that you receive the best possible returns and deductions.

By engaging in consistent and well-constructed tax planning, you can efficiently manage your deductions, liabilities, and remain within a legal framework.

As important as it is, tax planning is not often something we look forward to. In fact, the rules and regulations surrounding taxes are complicated at best and outright confusing at worst. It’s worth spending some time to understand some nuances of taxes for the long-term betterment of your finances.

Below are three important tax planning strategies that you should know about before you make another economic decision.

It’s worth remembering that any doubts are best cleared up by a wealth management advisor, who can guide you through the complex world of tax for your personal situation.

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  1. Understand Your Tax Bracket Before Planning

    It’s hard to craft a concrete plan if you don’t know what you’re planning from. What’s your base? Any tax planning exercise should start with understanding which tax bracket you fall in under federal law.

    Some important things to consider when determining your bracket are:

    • The United States has seven federal income tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

    • The country uses a progressive tax system that puts more tax burden on people with higher taxable incomes. Those who earn lower taxable incomes will pay less in real-term rates.

    Despite the fixed tax brackets mentioned above, most people will never pay their percentage bracket rate across their total income.

    There are two reasons this is the case:

    1. Taxable income includes subtracted deductions, which reflects in the difference between your salary and taxable income.

    2. When assessing your tax rate, the government splits your taxable income into separate chunks that are taxed individually.

    That may seem complicated, but it is simpler than it appears. If you have a single tax file with a $40,000 taxable income, you are in the 22% tax bracket during the 2020 tax year. However, this does not mean you will pay 22% but will pay a lower bracket for one chunk and then 22% for the remaining chunks.

  2. Understand What Tax Records To Keep

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    People are often overwhelmed when facing their yearly tax because they are unsure which tax records they need to keep. There’s no doubt keeping the correct documents and tax information is vital and will mean you can feel confident if you’re ever audited.

    How long should you keep your tax records? Well, holding onto them for many years is wise, but three years is the minimum time you should hold your records. This is the timeframe the IRS uses to decide whether to audit a tax return.

    Needless to say, that does not mean you should throw your tax records in the trash after three years. There are certain situations where the IRS can wait longer to start an audit of your finances.

    • Six years: For under-reported income over 25%.

    • Seven years: For written off losses from “worthless security.”

    • Indefinitely: For people who didn’t file a return or committed tax fraud.

    Below is a table charting all the documents you should keep as part of your tax records:

    Income

    • Bank Statements
    • Brokerage Statements
    • Alimony Received
    • K-1 Forms
    • W-2 Forms
    • 1099-int
    • 1099-div
    • 1099-misc

    Household

    • Insurance Records
    • Purchase Invoices
    • Service Invoices
    • Property Tax Assessments

    Retirement

    • 401(K) Statements
    • Annual Statements
    • Form 8606
    • Annual Statements
    • Form 5498

    Expenses And Deductions

    • Invoices
    • Gambling Losses
    • Charity Statements
    • Alimony
    • Receipts

    Investments

    • Purchase Receipts
    • Statements
  3. Understand Tax Deductions And Tax Credits

    When planning your taxes, there’s not much good news to go around because you will pay money off your income. However, there are some perks during the process, such as tax deductions and tax credits. While both function to reduce the amount of tax you pay, they are different processes.

    Many people confuse the two, so it’s important to know the difference between credits and deductions.

    1. Tax credits are your best tax-back tool – they allow you to have a reduction in your bill that matches dollar for dollar. For example, a tax credit of $600 would reduce your tax bill by $600.

    2. Tax deductions are similar but not as lucrative – they are for expenses you incurred that don’t count towards your taxable income. There are also surprising items that qualify for deductions that many people aren’t aware of.

There’s more to know

The three strategies listed above will set you up for understanding your tax returns and preparing yourself more efficiently. That said, they are also the tip of the iceberg and several additional strategies are worthy of attention, including knowing the difference between itemizing and deductions, learning what common tax credits are, and understanding methods of reducing your tax bill.

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