When most people think about tax planning, they envision one of two things:
- Planning time for tax preparation;
- Something wealthy people do to avoid high taxes.
While wealthy people and those with complex finances do engage in tax planning, it’s something everyone can do to keep more of their money rather than giving it to the IRS. To help you learn how you can reduce your taxable income without actually reducing your income, our CPA firm in Raleigh is sharing some tax planning tips for beginners.
What Is Tax Planning
Tax planning is simply looking at your finances and taking steps that maximize eligible tax deductions and minimize your tax payments at the state and federal level. This can be both a short-term plan to reduce your payments each year as well as long-term planning that will factor in your long-term goals and ensure your family and legacy will be minimally impacted by taxation.
Before we dig into deductions and credits, it’s important to make sure your withholding taxes are accurate. For example, any time you have a life event, such as have a baby, get married, adopt a child, or get divorced, your paycheck withholdings should be adjusted to reflect this. This will ensure you aren’t hit with an unexpected increase in owed taxes in April or are having too much taken out throughout the year that you could be putting to better use. If you need help with your individual tax planning, one of our CPAs can help!
Understanding Tax Deductions and Credits
With the Tax Cuts and Jobs Act of 2017, most people had to choose between taking an increased standard deduction rather than itemized deductions. However, there are still several deductions and credits you may be eligible. So, what’s the difference between a tax deduction and a tax credit?
A tax deduction reduces your taxable income and thus, reduces how much of your income can be taxed. Mortgage interest and student loan interest are deductions that would reduce your taxable income.
A tax credit gives you a specific amount off of your tax bill. The child tax credit is $2,000 per child under the age of 17 who you claim as a dependent, thus, no matter how much your taxable income is, you will immediately pay $2,000 fewer dollars in taxes for each child under 17.
How to Reduce Taxable Income
Taking steps to reduce your taxable income throughout the year using “tax shelters” will minimize your payments or help you get the largest refund possible.
If your employer offers a 401(k) retirement you can contribute a portion of your income up to $19,500 annually from your paycheck directly into the 401(k) account. This is pre-tax, so it reduces your taxable income from your paycheck. A traditional individual retirement account (IRA) allows you to direct pre-tax income into a tax-deferred account up to $6,000 per year or $12,000 for a couple.
If you earn $100,000, and you contribute $15,000 to a 401(k) and $5,000 to your IRA, your taxable income has been reduced to $80,000 so you’ll pay a significantly lower amount while growing a nest egg for your future.
Health Savings Accounts
A health savings account doesn’t just make it easy to set aside money to use toward extra medical costs that insurance doesn’t cover, it also reduces your tax payments. A HSA deduction reduces your taxable income up to $3,500 for an individual or $7,000 for families when you max out the contribution, and it’s not an itemized deduction, meaning you can claim this along with the standard deduction.
Unlike a retirement account, where you are expected to pay taxes on the money once you begin withdrawing it, withdraws from HSA funds for health-related spending is not taxed.
529 Savings Accounts for College
A 529 is an investment account, similar to a 401(k) or IRA but is designed to save for college costs to a designated beneficiary such as your child or grandchild. While you can not deduct money you put into it from your annual federal taxes, the money is not taxed when it’s taken out to pay educational costs, and it’s not affected by the capital gains tax.
Schedule a Consultation with a CPA in Raleigh or Durham Today
If you’d like to take steps that will reduce your tax burden both for the short-term and long-term, we can help you do it. Schedule a consultation with an experienced accountant today by calling (919) 872-0866 or filling out the form below to get started. With offices located in Durham and Raleigh, we serve a wide community of businesses and individuals.