Income tax planning is an important part of managing finances. Personal income tax is inevitable, but planning can manage the timing of income tax owed and maximize your tax refunds.
For example, the tax consequences of capital gains might one year be very difficult to manage, and in another year more favorable. There are limits to any tax deduction, which can be different for everyone. It is best not to assume anything in tax planning.
Tax advice from a professional financial planner or tax accountant is always preferable to guess work. The following are not intended to take the place of professional financial or tax planning advice but are general strategies that can be followed by most taxpayers.
One important note to make here is that overall tax planning strategies for any individual or family should be made in light of their long-term financial goals. Tax planning strategies may go hand in hand with retirement and savings plans.
When it comes to tax planning strategies that work, these should not only focus upon reducing the tax liability now, but also how this affects the overall long-range goals of the individual.
Retirement Plans
In its simplest form taxable income is the individual’s or family’s adjusted gross income. Retirement funds such as 401Ks are such an example. When tax time rolls around an eligible individual, who puts ten thousand dollars in their 401k reduces their adjusted gross income by the eligible amount.
Tax planning strategies almost always include a 401K plan or other types of retirement plans when possible because this defers the tax liability to a later date that fits in with the long term needs of the individual.
Owning a Home
Home ownership has always been a good tax planning strategy. There are fewer allowances made for tax deductions for the renter compared to the owner.
The homeowner however may spend the same amount on a home as a renter, but find that more of the money spent on shelter can be used in helping reduce the amount of taxes owed. The interest on a mortgage can be tax deductible up to a certain amount. There are other deductions applicable to the homeowner depending on their circumstances.
Charitable Donations
Charitable donations can be part of a well thought out tax strategy. All too many individuals who donate on a regular basis to religious or humanitarian foundations forget these can be used as a tax planning tool.
It is important to know and understand the current cap on donations but reporting these regular contributions can reduce the overall amount of tax a taxpayer owes each year.
There are very specific limits to these donations and contributions but when used wisely these can help both the taxpayer and the organization receiving the funds or goods.
Education Tax Credits
Educating children is costly. That is the lament of the American taxpayer particularly when it is time to send their children to college. There are however some tax credits that can be applied to educating each child and these should be part of the overall tax planning strategy.
A special savings account for college may be tax favored. Earnings and growth can accumulate without being taxed and as long as the fund is used for college education (within certain limits); it can be an exceptional tax saving strategy.
Tax credits such as the Lifetime Learning credit and the American Opportunity credit are once in a lifetime credit for educating one child or individual.
Tuitions for college are also deductible within certain income brackets. Planning the timing of these credits should help reduce tax liability for a specific year. These tax credits may be available only to individuals in a specific income bracket and gradually diminish or disappear for higher income bracket taxpayers.
Keep Long Term Goals In Mind
In conclusion, an individual or family’s tax planning strategies should be based upon their circumstances. The fact that a once in a lifetime credit may be available does not mean it is the best strategy to take it right then, or that deferring that credit is a good idea.
An example might be the family that barely qualifies for the Lifetime Learning Credit when a child first enters college, and who also expects their income to increase over the next year might be better advised to take it then. However, there are circumstances where the best tax strategy is to defer taking a credit one year, if it would benefit more the next.
Tax planning strategies should not only take into account the taxpayer’s current situation, their long term goals but also any proposed changes in credit laws in order to best serve the individual or family financial goals.
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