You know the old adage, the only certainties in life are death and taxes.
While you can’t avoid them, you can at least make taxes more bearable. How can you do that? With proper tax planning.
The major mistake that taxpayers make with their taxes is that they just worry about them between January and April. There are plenty of planning of opportunities outside of that window, and if you don’t start planning now, you can pay much more in taxes than you should.
Read on to learn the top tax planning strategies you should employ in 2020.
1. Know Your Status and Tax Bracket
The tax code is complicated, there’s no doubt about that. It’s so complex that about half of Americans don’t know their tax bracket.
If you don’t know your tax bracket and filing status, you’re basically guessing how much you’re going to have to pay in taxes.
Your income tax bracket tells you the percentage of income you’ll pay. You could pay anywhere between 10% to 37% percent on your adjusted gross income.
2. Standard Deduction vs. Itemizing
Do you know what your adjusted gross income is? Your AGI is the income that you’re actually taxed on. So, if you made $50,000, you may not be taxed a percentage of the money you earned.
Rather, you lower your taxable income through deductions and tax credits. Every taxpayer is entitled to a tax deduction, called the standard deduction.
The standard deduction doubled with the passage of the Tax Cuts and Jobs Act of 2017.
The alternative to taking the standard deduction is to itemize your taxes. When you itemize your deductions, you list your expenses that will lower your income.
For example, mortgage interest is a tax deduction. State and local taxes (SALT) taxes are deductible with limits.
If you find that when you itemize your deductions, the total is more than the standard deduction, you’ll want to file with itemized tax deductions.
On the other hand, if you don’t have a lot of deductions to itemize, you’re better off taking the standard deduction.
3. Take Advantage of Tax Credits
There are tax credits you can take along with tax deductions to lower your adjusted gross income. For example, the Child Care Credit and Adoption Credit give you tax credits to help you defray the costs of caring for and adopting a child.
If you made investments in your home to make it more energy-efficient, there is a residential tax credit that you may be eligible for.
These tax planning strategies show you the difference between a tax credit and a tax deduction.
4. Don’t Wait to Save for Retirement
Have you thought about saving for retirement? You don’t want to start saving when it’s too late. There are tax planning incentives to encourage you to put money aside into a 401(k) or IRA.
If you have a job that offers a 401(k), you can take money from your paycheck and put that money directly into a 401(k) plan tax-free. In 2020, you can contribute up to $19,500.
If you don’t have a 401(k) plan through your job, you can fund an IRA (either Roth or Traditional) up to $6,000.
These are smart tax planning strategies that you can employ now to get your ready for retirement.
5. Keep Excellent Records
Record keeping is an important part of doing taxes. You don’t know if or when your taxes are questioned and audited.
It’s best to hang onto your documents for at least three years. If you have a business, keep your records for up to seven years.
6. Double Check Your Withholdings
If you find that you always get a huge refund or that you owe quite a bit of money in April, you’ll want to double-check your tax withholdings with your employer.
You don’t want to pay too much in taxes during the year, because you’re giving the government a loan that’s interest-free. It may be nice to get a windfall every April, but you could be doing other things with that money during the year.
You also don’t want to get caught with a huge tax bill that was unexpected. You would have to work with the IRS to figure out how to pay it back.
If you’re self-employed or have a business, you’ll want to work with a CPA to make sure you pay enough in estimated taxes so you break even.
7. Defer Taxes When Possible
One tax strategy that beginners don’t know about is that you have the ability to defer taxes. As you build up wealth or a business, you may be able to employ tax planning strategies that allow you to defer taxes.
For example, if you have a business or you’re self-employed and account on a cash basis (January 1 – December 31), you may be able to put off invoicing customers in December so you won’t get paid until January 2021.
That will essentially defer your taxes owed on that income until 2021.
Another example is where you have real estate that’s used for business use. If you decide to sell that property, you’d have to pay capital gains taxes on the profit.
You can defer your capital gains taxes by using a 1031 exchange. It’s a complicated process, but in the simplest terms, you take the profits of your sale and apply the proceeds to the purchase of a replacement property.
Tax Planning Is a Year-Round Thing
Yes, the tax code is complicated and hard to understand. That shouldn’t stop you from using tax planning strategies that are available to all taxpayers.
You want to make sure you understand your income tax bracket and how you can lower your tax bill with deductions and tax credits. It also helps to save for retirement and defer your taxes when it makes sense to do so.
Be sure to come back to this site often for more great financial tips.