Pat yourself on the back. You have completed your taxes and filed away your return, never to be seen again. But before this tax season becomes a distant memory, why not make plans for next year?
We’ve all heard the importance of planning, but how many of us have applied the sage advice towards our taxes? Here are some strategies to help your overall financial plan to be more tax-efficient while helping your tax advisor (or you, for DIYers) be more filing-efficient:
Most of us wait until the week (while others wait until the day) before we meet our tax guy or gal to shove mounds of crumbled receipts, unperforated W-2s, and an inch thick worth of bank/brokerage statements into a manila folder.
But whether you do your taxes on a DIY tax software or go to a tax professional, why not save time for all parties involved? Start filing your records in an accordian folder. Have individual tabs categorized to help separate and identify the various records: W-2s, 1099s you earned, 1099s you paid, asset statements, large ticket receipts, etc. Have the folder somewhere visible where you can file your items when available.
There are a multitude of ways to either lower or postpone paying taxes in the current year. You can contribute money into your retirement account(s), tax harvest your losses from a brokerage account(s), and/or deduct interest on your student loans or a mortgage, if you own a home, to name a few. Keep in mind, the IRS allows us to legally avoid (mitigate) taxes, just not evade taxes.
Tax results can differ drastically by having more credits vs deductions. What is the difference you ask? A tax credit is a dollar for dollar reduction of the taxes owed while a tax deduction lowers your tax liability by reducing the taxable income. Clear as mud? A simple example is if you are single and have an income of $40,000. As a single taxfiler, the IRS allows you a deduction of $12,400 (in 2020) allowing your taxable income to be $27,600 ($40,000 minus $12,400). Say your tax rate is 12%, you would owe $3,312 ($27,600 X 12%) to Uncle Sam. On the flip side, say you had a tax credit of $3000, using the previous example, the taxes owed would be $312 ($3,312 minus $3,000).
For those who are charitably inclined, you can enjoy an added benefit due to the CARES ACT that was passed in March of 2020. Prior to the new changes, if you donated cash to your favorite organization, you could only deduct up to a maximum of 60% of your adjusted gross income (AGI). Since the changes, 100% of your donations is now tax deductible. In other words, if you donated $5000 this year, you would be able to deduct $5000 from your taxable income. Take note that this deduction can only be used if you are itemizing.
What many us realize too late is that if you plan on hiring a tax professional to do your taxes, you have to sign up early. There is a limit to how many new clients a tax preparer can handle each season and once the capacity limit is filled, the doors close up and you may be left scrambling to find someone who still has room. Don’t be left behind — secure a spot sooner than later. For those who are used to filing taxes using a home based software, you should still explore your options early to have ample time to research your product of choice. Not all are created equal nor user friendly.
Don’t wait until it’s too late to make the right moves before the next tax season. Reach out to your financial planner or tax professional now to discuss a plan that will help you succeed in your goals.
I am excited to introduce Liam Wall, our Summer Intern and business student at Loyola Maramount University, who will be contributing his time and sharing his knowledge on Otium’s ET SIMPLEX SOLUTIO Blog site. He will be submitting two personal finance articles in July (and possibly two more in August) that, without a doubt, will be informative and thought provoking. Hope you enjoy!