Introduction
Nobody likes to think about taxes, but it's something that is eventually inevitable. Every year, hard-earned money is distributed to the IRS, and for many this means a significant chunk of what was earned. This article will discuss some tips for tax planning, as well as common mistakes to avoid in order to stay on the Internal Revenue Service's good side.
What is Tax Planning?
Tax planning is a strategy for minimizing one's tax liability by taking advantage of available deductions, credits and other incentives. It involves strategically using the tax law to take full advantage of credits, deductions, and other incentives to reduce your tax liability.
Tax planning should be done at least annually to review your financial situation, determine potential tax savings, and ensure you are in compliance with the Internal Revenue Service (IRS) rules. It's important to recognize tax planning opportunities and make changes throughout the year, rather than waiting until the last minute.
It is important to note that tax planning is not tax evasion. Tax evasion is an illegal avoidance of taxes, while tax planning is taking legal steps to reduce your taxes.
Common Tax Planning Strategies
There are a variety of different tax planning strategies available, so it's important to understand how each of them works and how it can benefit you in your particular situation. Here are a few common ones:
Use your adjusted gross income (AGI): Your AGI is the amount left after subtracting expenses from your gross income. It is a key element of your taxes, and it can be manipulated to reduce your tax liability. If possible, try to decrease your AGI by either deferring income or making use of any deductions or credits available to you.
Maximize Retirement Accounts: Retirement accounts provide great savings opportunities for those who are eligible for them. Contributions to retirement accounts should not be overlooked, as they can be used to decrease your AGI, resulting in lower taxable income.
Contribute to Donor-Advised Funds: Donor-advised funds are charitable donation vehicles that allow individual donors to make tax-deductible donations. Donors can contribute funds into a donor-advised fund and then use the funds to make charitable donations over time. This offers a great tax advantage, as the donations are deductible when they are made, and not when they are used.
Claim Tax Credits: Tax credits and deductions can help to reduce your total tax liability. Two of the most common tax credits are the earned income credit and the child and dependent care credit.
Consider Tax-Loss Harvesting: Tax-loss harvesting is a method of using losses from investments to offset taxes on other gains. By strategically harvesting losses from one investment, the investor can reduce their taxable income, thus leading to a lower overall tax rate.
Common Mistakes to Avoid
Tax season can be overwhelming, so it’s important to stay attentive and mindful when filing your taxes. Here are some of the most common mistakes to avoid while preparing your tax return:
Not double-checking your returns: Accuracy is key when filing taxes, so it’s important to double-check all your information for accuracy. This includes making sure all your Social Security numbers and total income amounts reported are correct.
Missing out on deductions: Deducting as much as possible from your taxable income is important, as it can help to significantly reduce your tax bill. Make sure to do your research on all the potential deductions you may be eligible for and make sure to get them all on your return.
Forgetting to sign your return: This one may seem obvious, but it’s important to remember to sign your return if you’re filing it electronically or by mail. Doing so will help ensure your return is accepted by the IRS.
Not filing an extension when necessary: If you find yourself short on time when tax season rolls around, it’s important to remember to file an extension if you need one. Filing an extension will give you extra time (up to 6 months) to prepare your return, which can take some of the pressure off.
Incorrect filing status: Filing your return with the wrong filing status can significantly increase your tax liability. Make sure to double-check your filing status to ensure it’s the most beneficial one for you.
Not Repaying Tax Debts: If you owe money to the IRS from an outstanding debt, paying back that balance as soon as possible is important. Not doing so can result in serious consequences, such as wage garnishment or tax liens.
Conclusion
Tax planning is an essential part of a successful financial strategy. While it can be intimidating, it’s important to take the time to understand the tax laws and take advantage of any deductions or credits that can be utilized in order to minimize your tax liability. Adopting a sound tax planning strategy will help to ensure that you are staying in compliance with the IRS and staying on their good side.