Even just a little tax planning can help save you money when tax time comes. Among other things, tax planning can help you and your accountant or tax advisor evaluate your financial situation in light of the current tax laws.
Below are some basic ideas and strategies you and your tax advisor might use to manage your tax burden.
Consider tax planning before making any of the following financial moves or life changes:
- Borrowing money or paying off a loan
- Contributing to or taking a withdrawal from any retirement plan
- Buying or selling property
- Getting married
- Negotiating a divorce agreement
- Making investments
- Providing a large gift to a relative, including children
- Changing the structure of your business to a partnership or corporation
- Incurring business expenses as an employee
When is the best time to start?
People can often get the most benefit from tax planning by making it a consideration throughout the year. However, careful planning in the last quarter of the year can be most advantageous.
At that time, law changes and new tax rates are usually established, and some time remains in the year to make financial adjustments.
Timing is key to tax planning
Two basic concepts guide most tax planning: The first concept is that you should postpone tax payment as long as possible provided the government will not impose a penalty on you.
By postponing a tax payment without penalty, you’re almost getting an interest-free loan from the government, as you have use of the money until the tax is due.
The second concept is that you should consider year-to-year tax bracket changes when making decisions to pay deductible expenses or receive taxable revenue. Law changes or fluctuations in your income and expenses might shift you to different tax brackets from year to year.
Generally, you want to try to earn revenue in years your tax rates are low and pay expenses when your tax rates are high.
By planning ahead, you can adjust withholding and estimated tax payments to help eliminate or reduce tax penalties.
Making adjustments might also help you postpone payment of tax or let you shift some income or deductions to different tax years to lower your taxes.
Retirement contributions lower taxes
One reason financial advisors recommend contributions to a retirement plan as a way to reduce your tax bill is that most contributions, depending on the type of plan, are tax write-offs that do not require itemization.
Because your contribution to a traditional individual retirement account (IRA) is a pretax contribution, it lowers your taxable income, and you will owe less in income taxes regardless of whether you take the standard deduction.
Because contributions made until the April 15 tax deadline can be applied to the return for the previous year, they have been popular with people who want to lower a large tax bill after the year is over.
Spending lowers taxes
Sometimes, you can save on taxes by spending money elsewhere. Many employers offer a benefit that allows people to lower their tax bill using money they had planned to spend anyway, such as on dependent care or medical expenses.
Flexible spending plans are pretax plans that allow certain expenses, such as dependent care, medical expenses, and health insurance, to be paid with tax-exempt dollars.
Because contributing to a flexible spending account lowers your gross income, your taxable income becomes lower.
Giving lowers taxes
Charitable contributions can reduce your tax bill — anything from financial donations to donations of toys, books, clothes, and other used household items in reasonably good condition.
You also can deduct expenses from volunteer work, such as the cost of travel to an event where you represent the charity, though your time itself is not deductible.
Bundling lowers taxes
Some tax advisors recommend “bundling” charitable contributions to put what is essentially two years’ worth of deductions into a single year, increasing their deductions over the standard threshold and allowing the use of all the smaller, otherwise forgotten deductions.
The bottom line
There are many perfectly legal and reasonable ways to reduce your tax bill. You’ll find that a little foresight can go a long way toward saving you money — especially if you enlist the help of a tax professional.