It is time for year-end tax planning! You can do something about your tax bill just by doing a little tax planning. There is plenty of time to make a difference in your tax bill by just following these suggestions. Everybody knows they should do something, but they do not because either they do not know what to do or do not take the time to do it. The IRS is counting on you doing nothing!
Do you like receiving those huge refunds from the Internal Revenue Service? How do you explain getting a big refund check from the government? You do not receive interest or even a thank you, but you loaned the government money interest free for more than a year. Your generosity is amazing, but what does it do for you? I know many people consider the refund as forced savings, but you should receive interest. If you under withhold you may pay penalties and interest. It seems very one-sided!
United States tax code is progressive, which means the tax rates increases as the taxable base amount increases. Some people may call our tax code regressive because wealthier individuals are able to reduce their taxes much easier than our poorer individuals. It should not be a surprise because higher income individuals have access to more choices to reduce their taxes. Many of the tax savings require the excess earnings to shift expenses from year to year.
Year-end Tax Saving Tips
- Tax preparer or not? – When does it make sense to use a tax preparer? I learned how to prepare my income taxes when I was a high school freshman. I prepared my own taxes until I bought my first home. It helped that I was familiar with preparing taxes, but I knew that when I could deduct eligible expenses, it was time to get some professional advice. It may be a online tax calculator or CPA.
- Start with last year’s tax returns – I usually use what I filed for the prior year’s taxes as a basis for the current year’s tax planning. If something changed such as buy/sell real estate, change in earnings, investment gains or losses, IRA contributions/distributions, business/rental income, change in family, excessive medical expenses and much more. If you have enough changes, you probably should seek professional advice.
- Shift income and expenses – If you can, you should defer income to the following year and include expenses in the current year. You can prepay your mortgage and other (deductible) expenses by paying January’s payment in December. I routinely pay the entire property tax bill until I could no longer use it as part of my itemized deductions. Everything changed when my mortgage interest became a smaller and smaller part of my deductions. Looking for deductible expenses requires a checklist or checking with a tax professional.
- Investment gains/losses – You should time your investment sales, defer gains and take losses for tax purposes. Try to match your gains and losses in the same year particularly if you are in a higher tax bracket. This is a little bit more difficult with mutual funds, but still possible.
- Contribute to your 401(k)/IRA – Money contributed to a retirement plan lowers your tax obligation. I routinely contribute the maximum to my 403(b) and to my wife’s IRA. You can watch it grow tax deferred until you withdraw from it in retirement.
- Lower your tax refund – It is better to get a refund than owe taxes, but keep the refund sensible. A big refund means that you gave a no interest loan to the government during the year. I would rather have my money working for me during the year.
- Flexible Spending Account – If you can take advantage of an employee sponsored spending account, you should! A flexible spending account is a tax-advantaged arrangement which allows an employee to put aside a portion of their earnings to pay for qualified expenses such as medical or dependent care expenses. You are using pretax dollars for these qualified expenses.
I am a lifelong planner so tax planning is just part of it. A little planning can save you thousands in taxes every year. As a former CFO, it was my responsibility to plan taxes with the help of our accounting firm. I went through the same process for my personal taxes. It was particularly invaluable when I owned businesses and income property. The dollars may be smaller, but the goal is the same, to pay the least amount of taxes. Do you just complain about your high income taxes or do year-end tax planning?
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