Tax Planning

“It may feel good at tax time to get a refund, but remember that the money you’re getting back is money you loaned the government at no interest.”

Benjamin Franklin famously said, “nothing is certain but death and taxes.” Skip filing your taxes, and the tax agents will come calling. And when they do, you’ll likely face penalties and interest — and even lose your chance to receive a tax refund.

Unless your income is below a certain level, you will have to file federal income tax returns and pay taxes each year. Therefore, it’s important to understand your obligations and the way in which taxes are calculated.

Every year, everyone who makes money in the U.S. must fill out a prior calendar year tax return and file it with the IRS by April 15th. The process inspires dread among anyone who performs this task without the help of an accountant. The forms are complicated, and the definitions of terms like “dependent” and “exemption” can be difficult to understand.

Tax Basics and Taxable Income

There are two types of income subject to taxation: earned income and unearned income. Earned income includes:

Salary
Wages
Tips
Commissions
Bonuses
Unemployment benefits
Sick pay
Some noncash fringe benefits

Taxable unearned income includes:

Interest
Dividends
Profit from the sale of assets
Business and farm income
Rents
Royalties
Gambling winnings
Alimony

It is possible to reduce taxable income by contributing to a retirement account like a 401(k) or an IRA.

A person can exclude some income from taxation by using a standard deduction amount determined by the government and a person’s filing status or by itemizing certain types of expenses. Allowable itemized expenses include mortgage interest, state and local taxes, charitable contributions, and medical expenses.

Anyone can make an honest mistake with regard to taxes, but the IRS can be quite strict. And since everyone’s tax situation is a little different, you may have questions.

Allowed Deductions – Deductions and Tax Exemptions

The IRS offers Americans a variety of tax credits and deductions that can legally reduce how much you’ll owe. All Americans should know what deductions and credits they’re eligible for — not knowing is like leaving money on the table.

Most people take the standard deduction available to them when filing taxes to avoid providing proof of all of the purchases they’ve made throughout the year. Besides, itemized deductions often don’t add up to more than the standard deduction.

But if you’ve made substantial payments for mortgage interest, property taxes, medical expenses, local and state taxes or have made major charitable contributions, it could be worth it to take this step. These tax deductions are subtracted from your adjusted gross income, which reduces your taxable income.

The government allows the deduction of some types of expenses from a person’s adjusted gross income, or gross income minus adjustments. A person can exclude some income from taxation by using a standard deduction amount determined by the government and a person’s filing status or by itemizing certain types of expenses. Allowable itemized expenses include mortgage interest, a capped amount of state and local taxes, charitable contributions, and medical expenses.

Depending on who you are and what you do, you may be eligible for any number of tax deductions and exemptions to reduce your taxable income. At the end of the day, these could have a significant impact on your tax exposure. Starting with the standard deduction, the links below will help you determine how to shrink your income — for tax purposes, of course.

Common Tax Credits

Tax credits are also another way to reduce your tax exposure and possibly obtain a tax refund when the dust settles. Many people don’t realize that a tax credit is the equivalent of free money. Tax deductions reduce the amount of taxable income you can claim, and tax credits reduce the tax you owe and, in many cases, result in a nice refund.

The IRS offers a large number of tax credits that encompass everything from buying energy-efficient products for your home to health insurance premium payments to being in a low- to moderate-income household. The key to benefiting from these credits is examining all of the purchases you’ve made throughout the year to see if you are owed money.

There are 17 tax credits for individuals you can take advantage of in five categories:

Education credits
Family tax credits
Healthcare credits
Homeownership and real estate credits
Income and savings credits

Taxes: What to Pay and When

Most Americans don’t look forward to tax season. But the refund that a majority of taxpayers get can make the tedious process of tax filing worth the effort.

When you’re an employee, it’s your employer’s responsibility to withhold federal, state, and any local income taxes and send that withholding to the IRS, state, and locality. Those payments to the IRS are your prepayments on your expected tax liability when you file your tax return. Your Form W-2 has the withholding information for the year.

The U.S. has a pay-as-you-go taxation system. Just as income tax is withheld from employees every pay period and sent to the IRS, the estimated tax paid quarterly helps the government maintain a reliable schedule of income. It also protects you from having to cough up all the dough at once.

When you file, if you prepaid more than you owe, you get some back. If you prepaid too little, you have to make up the difference and pay more. And, if you’re like most wage earners, you get a nice refund at tax time.

But if you are self-employed, or if you have income other than your salary, you may need to pay estimated taxes each quarter to square your tax bill with Uncle Sam. You may owe estimated taxes if you receive income that isn’t subject to withholding, such as:

Interest income
Dividends
Gains from sales of stock or other assets
Earnings from a business
Alimony that is taxable

So, it’s important to remember that taxes are a pay-as-you-go. This means that you need to pay most of your tax during the year, as you receive income, rather than paying at the end of the year.

There are two ways to pay tax:

Withholding from your pay, your pension or certain government payments, such as Social Security.
Making quarterly estimated tax payments during the year.

This will help you avoid a surprise tax bill when you file your return. If you want to avoid a large tax bill, you may need to change your withholding. Changes in your life, such as marriage, divorce, working a second job, running a side business or receiving any other income without withholding can affect the amount of tax you owe.

And if you work as an employee, you don’t have to make estimated tax payments if you have more tax withheld from your paycheck. This may be an option if you also have a side job or a part-time business.

It may feel good at tax time to get a refund, but remember that the money you’re getting back is money you loaned the government at no interest.

References:

From Gratitude to Greatness: Brownlee Global's Path to a Purposeful Life

Guide and Educate Individuals How to Build Long-Term Wealth, Better Manage Their Money, and Achieve Financial Freedom

Like this:

Related