What Is Tax Planning?
Tax planning is the process of reviewing your financial information from the prior year before filing your tax returns. This is done by closely looking at what tax benefits you can take advantage of, planning big purchases strategically, reducing taxable income, and more.
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Tax planning is the practice of analyzing and arranging your financial situation in a way that allows you to minimize your tax liability, or the amount you owe at the end of the year. With proper income tax planning, you can get more tax breaks and pay fewer taxes when tax season rolls around.
In this article, we’ll do a deeper dive into tax planning and give you some year-end tax planning tips. We’ll discuss the basics of tax planning and tax season money management, including tax planning strategies that you can use to lower your tax bill. Keep reading to learn more about tax planning and how you can get started today.
What Is Tax Planning?
Tax planning is the act of setting yourself up for a lower tax bill, which can be accomplished by carefully timing income and purchases, among other things. Most people are required to pay taxes to the IRS, and those taxes can be a significant portion of a person’s income. With year-end tax planning, you can reduce your tax liability, which can mean you get a larger tax refund or a lower tax bill when tax season rolls around.
Tax planning can:
- Get your financial information in order
- Reduce your tax bill
- Plan ahead for tax payments
- Decrease tax-season stress
What Is Tax Planning vs. Tax Evasion
Keep in mind that there’s a difference between tax planning and tax evasion. Tax planning is using legal strategies to lower your tax bill, while tax evasion is the practice of illegally avoiding taxes that you’re supposed to pay. False tax returns are a common form of tax evasion. If you falsify your taxes, you may face penalties including large fines and time in prison.
Why Is Tax Planning Important?
Tax planning is an important part of minimizing your tax liability and making sure you can pay your taxes when tax season arrives. If you don’t file and pay your taxes on time, you may be subject to tax penalties. Here are some of the common tax penalties taxpayers face:
- Failure to file
- Failure to pay on time
- Failure to pay the proper amount
- Dishonored check
If you don’t file or don’t have enough to pay your taxes during tax season, these additional penalties can increase your tax bill.
When Should I Do Tax Planning?
While taxes are due in April, get started with tax planning as early as possible. Ideally, tax planning should be something you focus on throughout the year to prepare for tax season. The earlier you start planning, the more prepared you’re going to be.
What to Consider When Tax Planning
There are several ways to save money with tax planning, but personal tax planning is different for everybody. Here are some of the things to consider when tax planning.
What Your Tax Bracket Is
Your tax bracket determines your tax rate, or the percentage of your income that you’re required to pay in taxes. The higher your tax bracket is, the higher your tax rate is. Keep in mind that tax brackets are different depending on whether you’re filing single or as a married couple. Tax planning can help you reduce your tax liability, which helps you qualify for a lower tax bracket.
Whether You’ll Take the Standard or Itemized Deduction
You can either take the standard deduction for your tax situation, or you can take the itemized deduction that includes deductions for things like mortgage interest, charitable donations, and work-related expenses. You can only take one of these two deductions, so most people choose the larger of the two. A tax professional can help you compare your standard and itemized deductions to decide which one is a better option for you.
What Tax Deductions & Credits You Qualify for
Tax deductions and credits are an essential part of tax planning if you want to lower your tax bill. You may be eligible for tax credits if you have children, recently invested in renewable energy, or work out of a home office. While you may not want to go overboard and claim any tax credits or deductions that you’re not eligible for, these credits and deductions can be effective when it comes to lowering your tax bill.
Tax Planning Strategies That Can Lower Your Tax Bill
Tax planning is an important practice for both individuals and businesses, and there are a lot of resources that can help you get started. Here are some of the top tax planning strategies that can help you lower your tax bill.
- Maximizing Deductions & Credits
The first key to tax planning for individuals is maximizing your tax deductions and credits. Your eligibility can be based on several factors, so consider talking with a tax professional about the deductions and credits you might be eligible for. Here are some of the most common tax deductions and credits taxpayers qualify for:
- Child tax credit
- Charitable donations deduction
- Home office deduction
- Adoption credit
- Lifetime learning credit
- Savers credit
Understanding which you qualify for is a big part of tax planning. An expert can help you make sure you’re not claiming any deductions you’re not eligible for.
- Retirement Planning
Retirement planning can be another effective tax planning tool if you want to lower your current tax liability. The money you contribute to a 401k isn’t subject to income taxes until it’s withdrawn, which means you can reduce your tax liability by contributing your yearly 401k contribution limits. Not only does this help reduce your tax liability in the present, but it also sets you up for a better financial future.
- Flexible Spending Accounts (FSAs) & Health Spending Accounts (HSAs)
Similarly to your 401k, the contributions you make to flexible spending accounts (FSAs) and health spending accounts (HSAs) are also excluded from your taxable income. Keep in mind that HSA contributions are limited to $3,650 for individuals and $7,300 for families in 2022. Still, making your maximum contribution can reduce your taxable income and help you save money come tax season.
- Making Use of Charitable Contributions
Making a charitable contribution can be a good way to reduce your tax liability as long as you do it right. You can deduct up to 60% of your adjusted gross income for charitable donations you’ve made throughout the year. By grouping donations that would have been made over several years into one larger donation, you may be able to reduce your taxable income and lower your tax bill.
- Buy Bonds
Municipal bonds can be a solid investment if you’re looking to reduce your taxable income in a way that saves you money. When you buy a bond, you receive interest payments based on the cost of the bond and the interest rate. These interest payments are typically exempt from federal taxes, and they may be exempt from state and local taxes as well. This can make municipal bonds an attractive investment option, despite the fact that other bonds may offer higher interest rates.
- Make Long-Term Investments
While tax planning is often a short-term game, making long-term investments can be a good way to lower your tax liability and prepare for the upcoming tax season. Depending on your income and filing status, you may be eligible for a full or partial deduction based on the amount you contribute to your IRA.
If you haven’t started a retirement account, you may be able to open an IRA and make a last-minute contribution that you can deduct from your taxable income. This money grows in your retirement account and lowers your tax liability simultaneously.
Can You Get Help with Tax Planning?
There are tons of resources for taxes and tax planning on the internet, but what can you do if you need a little help? Working with a tax advisor may be a smart choice depending on your financial situation. You can always start by scheduling a consultation to talk about your tax situation.
Between our guide and all the other resources on the internet, you can learn the basics of tax planning on your own. When you combine tax planning with managing your finances through the Mint app, you can take control of your financial situation without hiring a pro.
Getting Ready for Tax Season Doesn’t Have to Be Overwhelming
Tax planning can be a good way to reduce your tax liability and lower your tax bill when tax season rolls around. That being said, effective tax planning is a year-round process, so don’t wait until tax season to start planning. If you need help, you can always hire a tax advisor. Alternatively, you can use the Mint app and other similar tools to keep track of your finances and help with tax planning.
Here are some other financial planning resources to check out:
Use this budget template to get organized.
Take steps toward better financial wellness.
Try these financial tips to improve your situation.
Plan for retirement with our free 401k calculator.
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The Financial Planning Process in 6 Steps