Most people sit down to calculate their income tax liability at the end of the tax year, and this often gives them surprises – not the most pleasant ones. Although you’ve got to file your taxes once a year, it doesn’t mean you can’t plan your taxes throughout the year. In fact, it’s wise to do tax planning year-round instead of sitting down when the water has passed the safe levels, and it’s too late to change things!
If you want to save unpleasant surprises, you should plan your tax proactively year-round. It may feel like too much work, but trust us when we say planning and working on your taxes year-round actually reduces the work (and the stress) at the time of tax filing.
This blog post lists down 6 year-round tax planning tips that you’ll be thankful for. It’s time you make your tax filing process easier, quicker, and less stressful.
1. Do an Income Tax Projection
Not having an idea about what income tax payable will be for the year will mean an unpleasant and stressful surprise. Doing an income tax projection for the year is one of the most important tips. An income tax projection will help you get an estimate of where your taxes stand and allow you to turn things around before it’s too late.
If you’ve got an idea of how much income tax you’ll have to pay ahead of time, you get enough space and time to prepare. You can look into ways to reduce your tax burden. If you’ve got no clue of how much taxes you’ll be required to pay at the end of the year and the value comes out as ‘too high’, you may panic, not knowing how to manage to pay your taxes.
2. Develop Strategies to Reduce Income Tax
Did you know if you planned properly year-round, you could reduce the income tax payable? It’s true. People who don’t do tax planning year-round often end up paying more in taxes than people who do. The income tax you’ve got to pay depends entirely on your taxable income. If you could devise a strategy to reduce your taxable income, you can possibly bring the income tax numbers down. It’s very much possible to defer and even eliminate your tax liability. This requires you to make qualifying contributions.
- Retirement Plans and Accounts – Tax-deductible contributions to the 403(b) plan, 401(k) plan, or traditional IRA can bring your income tax payable down.
- Health Saving Accounts (HSA) – Keeping your money in a health saving account offers triple tax benefits. They not only account as tax-deductible contributions but also as tax-free earnings and tax-free withdrawals for medical expenses (qualified only).
- Flexible Savings Accounts and Dependent Care FSAs – Keeping your money in FSAs and DCFSAs gives you an opportunity to bypass taxes since you’re saving for medical purposes. You’ll have to spend the funds that you keep in these accounts within a specific period of time, though. You can’t keep money in these accounts and bypass taxes for as long as you want.
- 529 Plans – A 529 plan allows you to save money for approved educational expenses. Transactions under this plan are counted as tax-free earnings and withdrawals.
3. Work on Minimizing Capital Gains Taxes on Investments
If you sell an asset at a higher price than what you bought it at, like stocks, you’ll be charged a capital gains tax on the profit you make. Depending on the value of the asset and the profit made, the tax payable can be a huge number. But it’s possible to minimize capital gains tax on investments and reduce your tax burden. Some ways you can do this include:
- You can transfer the assets to one of your children you aren’t dependent on you but fall in the lower tax bracket. This would reduce the capital gains tax.
- Don’t sell all of your appreciated assets in one go. Sell it in portions over 2 years. This would reduce the capital gains tax you’ll have to pay for your appreciated assets.
- You can transfer your appreciated assets entirely. You won’t have to pay capital gains tax on something that’s not under your name.
- Shift your funds to qualified funds for disadvantaged communities. This way, you can defer your taxes.
4. Benefit from Gift Taxation Rules
You can use the gift taxation rules to your advantage and reduce the amount of tax you’ll have to pay at the end of the year. You can transfer money as a gift to an individual every year without being taxed. The limit for this is $15,000 for single filers. A couple can gift as much as $30,000 to someone without gift tax or estate tax implications.
5. Make Charity Donations
Another way you can bring tax payable numbers down is by making charity donations. Making tax-deductible donations reduces your taxable income. When taxable income is reduced, income tax will reduce too.
6. Get a Wealth Management Advisor on Board
Tax planning isn’t the most straightforward thing that you’ll be doing. It’s not everyone’s cup of tea. Hiring an experienced wealth management advisor or a tax attorney can change things for you. Your financial advisor will do all the work to bring the numbers down so that when the tax filing time finally comes, you don’t get any surprises. All your documents and funds will be sorted, and you’ll be spared from the stress of tax filing.
As we said above, tax filing isn’t so straightforward and simple. If you don’t understand the technicalities of tax filing, it’s best to educate yourself about tax law and what is possible and what’s not. Once you’ve better understood the tax law, tax filing won’t feel as overwhelming. Even if you decide to work with a financial advisor, you won’t feel like a blank slate in front of them.
Visit Spirit One to familiarize yourself with tax law and understand the nitty-gritty of taxing laws.