Tax Planning for Beginners: 6 Tax Strategy Concepts to Know
Tax planning is the analysis and arrangement of a person’s financial situation in order to maximize tax breaks and minimize tax liabilities in a legal and efficient manner.
Tax rules can be complicated, but taking some time to know and use them for your benefit can change how much you end up paying (or getting back) in April. Here are some key tax planning and tax strategy concepts to understand before you make your next money move.
Tax planning starts with understanding your tax bracket
You can’t really plan for the future if you don’t know where you are today. So the first tax planning tip is get a grip on what federal tax bracket you’re in.
The United States has a progressive tax system. That means people with higher taxable incomes are subject to higher tax rates. People with lower taxable incomes are subject to lower tax rates.
There are seven federal income tax brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%.
No matter which bracket you’re in, you probably won’t pay that rate on your entire income. There are two reasons:
You get to subtract tax deductions to determine your taxable income (that’s why your taxable income usually isn’t the same as your salary or total income).
You don’t just multiply your tax bracket by your taxable income. Instead, the government divides your taxable income into chunks and then taxes each chunk at the corresponding rate.
For example, let’s say you’re a single filer with $32,000 in taxable income. That puts you in the 12% tax bracket for the 2019 tax year. But do you pay 12% on all $32,000? No. Actually, you pay 10% on the first $9,700; then you pay 12% on the rest. If you had $50,000 of taxable income, you’d pay 10% on that first $9,700 and 12% on the chunk of income between $9,701 and $39,475. And then you’d pay 22% on the rest.
The difference between tax deductions and tax credits
Tax deductions and tax credits may be the best part of preparing your tax return. Both reduce your tax bill, but in very different ways. Knowing the difference can create some very effective tax strategies that reduce your tax bill.
Tax deductions are specific expenses you’ve incurred that you can subtract from your taxable income. They reduce how much of your income is subject to taxes.
Tax credits are even better — they give you a dollar-for-dollar reduction in your tax bill. A tax credit valued at $1,000, for instance, lowers your tax bill by $1,000.
Taking the standard deduction vs. itemizing
Deciding whether to itemize or take the standard deduction is a big part of tax planning, because the choice can make a huge difference in your tax bill.
What is the standard deduction?
Basically, it’s a flat-dollar, no-questions-asked tax deduction. Taking the standard deduction makes tax prep go a lot faster, which is probably a big reason why many taxpayers do it instead of itemizing.
Congress sets the amount of the standard deduction, and it’s typically adjusted every year for inflation. The standard deduction that you qualify for depends on your filing status, as the table below shows.
Tax planning tips to maximise your return
The end of the tax year will soon be upon us with 30 June just around the corner. Now’s a good time to take a look at both your expected taxable income (essentially your business’s assessable income, minus any allowable deductions) for the current financial year 2018-19; and your projected/expected taxable income for 2019-20, as they will help guide your tax planning strategy.
If you are expecting to have a higher income this financial year, compared to your projections/expectations for the next financial year, you can talk to your accountant to consider:
Prepaying some of your 2019-20 expenses (such as your rent, insurance or subscriptions to professional associations) in the 2018-19 financial year. Up to 12 months of the following year’s expenses can be deducted in the current tax year.
Taking advantage of the instant asset write-off, which enables you to immediately deduct assets you purchase for your business costing less than the associated threshold (whether the asset is purchased new or second-hand). This opportunity will be available until 30 June 2020. Thresholds have changed over the past few years so check the ATO website for full details.
Reviewing and postponing some of your invoicing for the current tax year, if appropriate.
Topping up your voluntary superannuation contributions.
Reviewing your debtors and writing off any unrecoverable debts.
If applicable, deducting any start-up expenses – such as obtaining legal or accounting advice on your business structure, and fees in relation to establishing the structure (eg. ASIC company registration fee).
Tax Tips That Could Save You Money This Year
Decide whether itemizing is still for you
The new law greatly increases the standard deduction to $24,400 for married couples filing jointly, $12,200 for single filers in 2019. It also places new limits on itemized deductions, including a $10,000 cap on property and state and local income tax deductions. Taking the standard deduction instead of itemizing may make tax preparation simpler, Navani says. At the same time, work closely with your tax specialist to make sure it’s the right choice, which will depend on factors ranging from your health expenses to charitable giving
Max out on your retirement plan
The new laws don’t change this advice: Think about increasing your contributions to your 401(k), IRA or other retirement plan to reach the maximum contribution amount.
Not only does this offer the possibility of increasing your retirement savings, but it will also potentially lower your taxable income. If you’ll be age 50 or older at any time during the calendar year, take advantage of “catch-up” contributions (an extra $6,000 for a 401(k) plan and an added $1,000 for an IRA1), Navani suggests. You generally have until December 31, 2019, to contribute to a 401(k) plan and until April 15, 2020, to contribute to an IRA for the 2019 tax year.
Consider converting your traditional IRA to a Roth IRA
Although there are income limits for contributing to a Roth IRA,2 anyone can convert all or a portion of their assets in a traditional IRA (or other eligible retirement plan) to a Roth IRA. Why might doing so make sense? Unlike with a traditional IRA, qualified distributions from a Roth IRA aren’t generally subject to federal income taxes, as long as the Roth IRA has been open at least five years and you have reached at least age 59½. However, you’ll be required to pay income taxes on the amount of your deductible contributions, as well as any associated earnings, when you convert from your traditional IRA to a Roth IRA—or, if you don’t convert, when you retire and take withdrawals from your traditional IRA.
Use stock losses to offset capital gains
Now may be a good time to consider selling certain underperforming investments in order to generate a capital loss before the end of the year—which could help offset the capital gains you realize when selling stocks that are performing well. In addition, you may generally deduct up to $3,000 ($1,500 if married and filing separately) of capital losses in excess of capital gains per year from your ordinary income. If your net capital losses exceed the yearly limit of $3,000 ($1,500 if married and filing a separate return), you can carry over the unused losses to the following year. Note that under the new law, investors will continue to pay long-term capital gains taxes at a rate of 0%, 15% or 20% (depending on their overall income) but with adjusted cutoffs. Married couples filing jointly and earning $78,750 or less ($39,375 for singles) will pay nothing. Married couples filing jointly earning between that and $488,850 (or that and $434,550 for singles) will pay 15%, while married couples filing jointly and earning more than $488,850 or more ($434,550 for singles) will pay 20%.3
best tips to prepare for tax-filing season
as the end of the year approaches, it’s a good idea to start thinking about how you’ll handle your federal tax return. Some taxpayers are still getting familiar with the Tax Cuts and Jobs Act of 2017, which has been in effect for only one tax season.
The new tax law capped state and local tax deductions at $10,000, doubled estate tax exemptions, put new limits on the deductibility of home equity debt, and changed the tax brackets. It’s a lot to keep track of, so taxpayers shouldn’t wait until the April 15 filing deadline nears to plot their best course.
The IRS starts accepting 2019 returns on Jan. 28, 2020. Even if your financial situation is simple and straightforward, it pays to make sure you’re up-to-date and doing all you can to reduce your tax bill.
Quick tips to make effective last-minute tax planning
Equity Linked Savings Scheme (ELSS): ELSS is a diversified equity mutual fund which has a majority of the corpus invested in equities. Returns from an ELSS fund reflect returns from the equity markets. Investment can be made in lump sum. If you plan in advance, you can take the SIP route with a lock-in period of three years. It is considered one of the best investments as it has the potential to give returns of around 15% (based on past returns) along with tax deduction ..
Public provident fund (PPF): It is a savings scheme introduced by the Ministry of Finance (MoF) with tax benefits. The scheme is fully guaranteed by the Central Government and provides a fixed rate of return of around 8 per cent, which is fixed every quarter.
Employee provident fund (EPF): EPF is a retirement benefit scheme that is available to all salaried employees. The employer deducts a minimum of 12 per cent of basic salary plus Dearness Allowances (DA) of employee and deposits in the EPF or other recognised provident fund. This amount can be higher than 12% as per employee discretion. The interest rate on the EPF is 8.55 per cent and the entire PF balance (including interest) is tax-free if withdrawn after continuous service of ..