The concept of tax planning has, unfortunately, become the lazy habitual norm of our society. We either choose to do it at the very last minute or don’t care to indulge in at all. Alas, only to find out the number of advantages we could’ve benefited since the moment of filing a tax return.
A smart tax planner would know the difference between tax filing and tax planning. Tax filing has to do with how you legally prepare and send your tax return to the IRS before the deadline. Tax planning, on the other hand, involves paying your fair share of taxes without any extra penny.
A figure calculated by the General Accountability Office roughly estimated that 2.2 million taxpayers overpaid their taxes by $1 billion.
Businesses and entrepreneurs are adopting tax planning measures because they allow you to segment time to calculate past tax returns.Thus, it helps in finding new opportunities to decrease the amount that may be owed in the future.
Also, don’t lose sight of the cookie. You could invest the money saved from taxes for a vacation, retirement, or purchase a new car, or make an investment.
Besides, the value of your portfolio would significantly change due to tax planning and may as well impact the quality of your daily life.How? It could minimize your tax liability for the foreseeable future with lawful practices that use deductions, grants, and reliefs.
Types of Tax Planning
Tax planning could be short or long term in nature and is divided into two categories.
Permissive Tax Planning
Several deductions and planning could be achieved under the Sec. 10 and Sec. 10(1). And tax concessions are usually made to take advantage of your earned income via permissible provisions of the law.
Purposive Tax Planning
The plans in purposive tax planning are more clarified for the replacement of assets, diversification options, and selection of investment.
Tax Deductions
A standard tax deduction reduces the total amount of income liable to be taxed. Also, it is important to differentiate between a tax deduction and tax credit.
In simple terms, deductions are simply expenses that a taxpayer generates over a year, which can be cut from the adjusted gross income (AGI) to assess how much tax they owe.
The government offers tax deductions for the sole reason to encourage taxpayers to take part in the local community activities. The point is to make taxpayers aware of the eligibility criteria set for federal and state tax deductions.
Taxpayers divide their tax deductions into standard or itemized category. The standard deduction applies to federal taxes and changes per year. However, itemized tax deductions are used to cut the standardized deduction limit. This means that a small share of the burden of the calculation is on the shoulders of the tax filer as opposed to standard deductions; the amount is fixed and determined.
Why is Tax Planning Important?
Carefully planning your taxes is essential to increasing future saving, investment, and to ensure financial security instead of incurring a financial burden.
Here are some of the reasons why tax planning is so important:
Understand the Value of Year-Round Tax Planning
The battle is half won already once you successfully file your tax return before the deadline. This allows you to take feasible measures to improve your current financial health and plan tax time for the next year.
Looking Back at Your Tax Return
Regardless of how satisfied you are with the tax returns you have filed, always look back to assess them. They may give you more clues that may lead you to make the most of better opportunities and enhance your financial growth.
The trick is to try to make sense of it repeatedly until you’re extensively well-versed with all the facts and figures.
Prepare for College Education
You may remember that you have to list down your dependents at the beginning of your tax return. The fact of the matter is that individuals with children often bear the insufferable education cost. For instance, the American Opportunity Credit grants taxpayers an opportunity to substantially reduce taxes to as low as $2,500 every year.
Also, you have an option to save for future tuition expenses through a Section 529 plan investment account. With this plan, you can have your savings to be tax-free without added distribution. Furthermore, the amount could be transferred to the beneficiary to pay for college costs.
Nuclear families can make the most out of this to minimize overall education expenses.
Analyze Deductions
Every taxpayer’s Schedule A lists the deductions pertaining to the last year. Thus, taxpayers with alternative minimum tax (AM) lose any chance of deductions.
What’s the solution? It might be wise to increase or set back some portion of the income or deductions to get around the AMT.
And this added benefit applies especially to taxpayers who have a considerable amount of deductions on their home mortgage interest. Therefore,it is highly advisable to refinance your house to get a lower interest rate.
Although deductions will still be there, you can benefit from the additional interest money once your financial costs are lowered.
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Retirement Benefit
You might be missing out a great deal on arguably the most well-thought-out benefit of tax planning. Yes, you can have tax free earnings over time as long as you contribute to pre-tax income. And employer-sponsored plans, such as 401(l) and 403(b) can help you achieve that goal.
However, if you don’t have access to the plans above, the deductions could still be made through individual retirement accounts (IRAs) or simplified employee pensions (SEPs).
The purpose of saving over time is to make sure that there will be enough funds and comfort left for you after retirement.
Anyway, you don’t have to contribute an enormous amount to enjoy the tax benefits, but set aside as much as you can afford over time.
Individuals with a high tax bracket get to enjoy the usefulness of deferral taxation. Keeping that in mind, it’s completely normal to be placed in a lower tax bracket in the future for any withdrawals or distributions.
Freedom to Plan and Choose Estate Options
The laws governing estate taxes are constantly changing,which makes it hard to identify who will enjoy the added benefit over time.
Tax planning can help you select lower estate taxes and choose prioritized goals at the same time.
Retrieve Investment Losses
With the help of tax planning, you can enjoy investment gains on an income of up to $3,000 per year. You can sell any investment that may have lost value over time. And even if your losses somehow exceed the gains, you will always have the option to transfer the amount in future tax years.
Make Use of Charities
You can donate to charities of your choice when itemized tax deductions are made due to mortgage interest or other reason.
Although some of the most tax-efficient charities are associated with appreciated assets, the act of donating to charities will give you the benefit of not paying taxes on capital gains.
Whether you buy or lease a vehicle, you can enjoy a $0.14 per mile tax deduction by volunteering for an organizational charity.Meanwhile, you can also rely on monetary donations made specifically for charitable organizations.
Municipal Bonds
Municipal bonds can help avoid that extra tax rate of 3.8%Medicare surtax, which is usually associated with high-income earners.
And that’s just the tip of the iceberg; Municipal bonds can avoid Federal and State income taxes. This makes municipal bonds more valuable and in demand.
Transfer of Assets
Suppose you have an estate that is much larger than your exclusion amount, you can still get the money by giving it someone else.
You can reduce the overall value without paying federal taxes by allocating $12,000-$14,000 per year to your children, grandchildren,or another beneficiary. Similarly, your spouse can also transfer the assets of up to $28,000 per year.
Additional Deductions
If your current residence is not in the same city as the company’s branch you’re working for you have the option to choose their office as a home office to make necessary deductions. Sales executives who have to travel across the country often make these tax deductions.
The IRS now allows parents to pay back student loans and get sufficient tax deductions as well. Furthermore, money is commonly used to payoff student debts. Also, the forgiven amount is not taxable by Public Service Loan Forgiveness.
Taxpayers can deduct their medical expenses from adjusted gross income by 7.5% per year. As per 2019, AGI tax ratio could increase to 10%.
Concluding Thoughts
Tax planning is not something that can be applied in a single day or a hasty last-minute effort. It requires you to invest some time for the entirety of the year to recognize potential opportunities for tax savings and achieve the desired tax goals.
The nature of completing transactions should be tax-oriented to avoid impulsive mistakes. And seeking the help of a tax specialist would add more value in the long run.
