Let’s face it, it’s always exciting when you’re making more money each year. Who is not happy about that? Things are looking bright and you start planning more for the future.
But as you’re skipping along the happy trail, you feel like something is off. By your calculations, you’ve made 10 times more than what you did last year and yet, after you paid your tax bill, you feel even more broke than you did when you were making less!
You wonder just how you got here.
THE LIKELY ANSWER: Improper tax planning!
Let’s dive a little deeper…
WHAT IS TAX PLANNING?
Tax planning is analyzing your personal financial situation or plan to make sure that all the key elements are working in your favor to help you pay the LOWEST TAXES possible. In other words, there are specific strategies that are used to decrease your tax responsibility and put more money in your pocket.
Take a deep breath and exhale!
Here’s some tips to help you start planning.
First, before you can start tax planning you need to understand your federal tax bracket. The U.S. has a progressive tax system. This means people with higher taxable incomes have a higher tax rate, while people with lower taxable incomes have a lower tax rate. There are seven federal income tax brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%. You need to see where you fall income wise.
Next, you need to look at your tax deductions and tax credits.
WHAT’S THE DIFFERENCE BETWEEN TAX DEDUCTIONS AND TAX CREDITS?
Are tax deductions and tax credits the same? No. Knowing the difference between the two creates effective tax strategies that can reduce your tax bill.
Tax deductions are expenses you’ve incurred that you can subtract from your taxable income. These deductions reduce the amount of your income that is taxable.
Tax credits give you a dollar to dollar reduction in your tax bill. For example, a tax credit valued at $500 lowers your tax bill by $500.
Last, you need to decide on standard deductions or itemized ones. This is an extremely important step. It determines just how big (or small) your tax bill will be.
SHOULD YOU TAKE A STANDARD DEDUCTION OR AN ITEMIZED ONE?
A standard deduction is a flat rate tax deduction. Congress sets the amount which is typically adjusted yearly for inflation. Your filing status determines the standard deduction you qualify for.
Itemizing your tax return allows you to qualify for individual tax deductions, one by one.
Your tax professional would compare your itemized deductions total to the standard deduction you qualify for and make the decision using that information.
The tax prep is longer when you itemize but usually adds up to more than standard deduction. This isn’t always the case though.
Just like with every other tax strategy, it shouldn’t be a one-size-fits-all approach.
These are only a few key tips to let you know that there’s light at the end of the tunnel. Trying to figure it out on your own can be a bit confusing.
The best thing to do is to reach out to a financial professional. Let them help guide you so you can get back to planning your future.
Questions? Contact me today!