Tax time can be a stressful time of year for everyone, but everything becomes easier when there is a plan in place. Tax planning is a great tool to use for things like business, wills, retirement, and properties.
In short, it is a way to help figure out just how much money you will be spending on taxes per year, while figuring out the best ways to minimize your tax liability.
Here are four concepts you should know to make tax planning easier.
1. Tax Bracket
The first thing you need to understand when tax planning is your tax bracket. This is important because it gives you an idea of your current standing, which is vital before you can plan for the future.
The U.S follows a progressive tax system, meaning that the higher your income, the more money you pay in taxes.
There are seven general tax brackets (10%, 12%, 22%, 24%, 32%, 35% and 37%), but often times, you won’t pay that percentage on your entire income.
This is because tax deductions are taken into consideration and the government also divides your taxable income into segments before applying taxes.
2. Tax Deductions vs. Tax Credits
Both tax credits and deductions can reduce your tax bill, but they do so in different ways. Tax Deductions are expenses that you have that can be subtracted from your taxable income. Tax Credits are more beneficial, giving you a dollar-for-dollar reduction.
3. Standard Deduction vs. Itemizing
- Standard Deduction: A lot of taxpayers choose to utilize standard deduction because it’s a lot faster. A standard deduction is a flat rate, no questions asked deduction. The government sets an amount of the standard deduction each year and the one that you qualify for depends on your filing status (single, married, head of household)
- Itemize: This is a longer process, but typically ends up in more deductions than if standard is used. Itemizing means you take your tax deductions one by one. PL Consulting can help you determine exactly which deductions you qualify for and if it’s worth itemizing over using standard deduction.
4. Tax Records
A crucial part of tax planning is keeping all records of tax returns and documents. It can take the IRS up to three years to decide whether or not to audit your return, so you want to hold onto your records for at least that long.
If you’ve under reported your income by more than 25%, you want to keep your records for at least six years. If you’ve ever skipped a tax return, keep your files indefinitely.
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