Tax Planning Tips

Publications typically circulate their tax planning tips at the end of the tax year. Quite frankly, tax planning can take place all year long. It's something you really want to start planning now, whether tax season is 12 months away or just around the corner.

Tax Planning Strategies

For many of us, our tax planning strategies should be aligned with a simplified income tax formula:

Gross Income - Deductible Expenses = Net Taxable Income

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The overall tax-planning objective is to minimize net taxable income. The tactics involved with meeting that objective are twofold: minimizing your gross income, while maximizing your deductible expenses. The following tax planning tips are going to look at each of these tactics separately.

Minimizing Gross Income Tips

Just so there is no confusion, we're not talking about extremes like quitting your job. No doubt you could minimize your taxable income by taking some time off from work, but that's not going to help your lifestyle in the long run.

The tax tips we're going to talk about in this section include tactics you can follow to exclude your income from federal income taxes. Therefore, our first tip has to do with those retirement years.

Tax Tip 1: Lowering Gross Income via 401k and 403b Plans

It's no accident that this is the first tax planning tip listed. If you're looking to lower your tax bill, then one of the most effective ways to keep more of your gross income is to have it directed into a 401k or 403b plan.

The 401k rules are quite generous when it comes to lowering income, and they are mirrored by the 403b contribution rules. On a pre-tax basis you can invest up to $17,000 in 2012 (16,500 in 2011), and your contributions are often matched by your employer. In 2013 and beyond these contribution amounts will rise with an index of inflation. That means you can lower your taxable income by $17,000, get an instant return on investment, and save for retirement at the same time. It's really a win-win.

Tax Tip 2: Deferring Income

A second way you can lower your gross taxable income is by deferring income. The objective here is to defer money, or income, to another tax year. Perhaps the best example of deferring income to lower taxable income is using the tax laws to defer stock market gains.

This is probably the most controversial tax planning tip we are going to offer, but if you have shares of stock that have gone up since you've purchased them, then you might want to defer taking that capital gain and raising your gross income. This is especially desirable if you can offset that capital gain with a capital loss in later years.

Keep in mind the IRS disallows the loss on sales of securities if substantially identical securities are purchased within 30 days. This is called a wash sale.

Maximizing Deductible Expenses

If your individual circumstances do not allow you to take advantage of the two tax planning tips we've offered to lower your gross income, don't be discouraged. When it comes to maximizing deductible expenses, the tax code provides many opportunities to taxpayers. There are tax deductions that we're going to list in these tips that anyone can take advantage of this tax season.

We'd like to make one clarification. Even though we've labeled these tips as deductible expenses, we're really talking about two items: tax deductions and tax credits. A tax deduction lowers your taxable income, while a tax credit is just that... It's a credit to your total tax bill. That makes tax credits far more valuable on a dollar-for-dollar basis.

Tax Tip 3: Tax Credits

Our next series of tax planning tips are those that provide tax credits. Admittedly, the qualifying rules are quite complex and very specific to each program. But that doesn't mean you shouldn't explore any or all of these options to see how they might be used to lower your taxes.

Child Tax Credit: The child tax credit provides you with a tax credit of $1,000 per qualifying child under the age of seventeen. This credit is phased-out for taxpayers with modified adjusted gross incomes (AGI) in excess of $110,000 for married-joint filers, $55,000 for married filing separately, and $75,000 for all other taxpayers.
Hope and Lifetime Learning Credit: If you're paying secondary education expenses, then the American Opportunity Credit, Hope Credit and Lifetime Learning Credit provide tax credits up to $2,500 for each qualifying student enrolled in a qualifying institution of higher education.
Child and Dependent Care Credit: If you're paying someone else to care for a child under age 13 so you can work, then you may be able to claim the child and dependent care credit. As with most tax credits, your total credit may be lowered or eliminated for individuals with higher adjusted gross income.
Hybrid Car Credit: If you buy or lease a new hybrid car or truck, then you may be eligible for a tax credit of $250 to $3,400 per car depending on the fuel economy of the vehicle. New car manufacturers will be happy to provide you with the details of these tax savings programs.
Energy Saving Devices: If you're a homeowner that installs some of the newer energy saving devices such as air conditioners, water heaters, furnaces, boilers or solar panels, then you may be eligible for a tax credit of up to $2,000. Check with your local electric or gas utility to find out which energy saving devices provide tax credits or rebates.

Tax Tip 4: Tax Deductions

Our final set of tax planning tips has to do with tax deductions. If there is one place where any taxpayer can find a way to lower their taxable income, it's through tax deductions.

Once again, we're not talking about buying a new home just so that you can deduct your mortgage interest and property taxes. We're talking about some of the actions you can take to squeeze out more deductions. Perhaps even to your own benefit in the long run.

IRA Accounts: Roth IRAs do not provide immediate tax help, although the money removed from these accounts is not considered taxable income. If you're looking for immediate tax relief, you might want to consider funding a Traditional IRA, which can be tax deductible. It's just another way the government provides tax incentives to save for retirement.
Medical Expenses: No one plans to get sick, but there is one way to use those medical expenses to your advantage. Only the medical expenses in excess of 7.5% are allowed as tax deductions. That's where the strategy of grouping medical expenses comes into play. This strategy is fairly simple. If you've been hit hard with a lot of medical expenses in a given year, then you may actually decide to accelerate additional elective medical payments into the same tax year. This way you can take advantage of your medical expenses, even with the 7.5% threshold.
Homeowner Deductions: You can accelerate your mortgage and property tax deductions merely by changing the timing of your payments. By writing your checks before December 31st, you can claim the interest expense or property taxes in that same tax year.
Business and Personal Expenses: This final tax planning tip has to do with accelerating some of your personal or business-related expenses. By charging some of these expenses on your credit card, you can claim the expense in one tax year, and pay for them in the following year. We're not talking about unnecessarily running up your credit card balance. Just paying for some expenses before the New Year.

Prepaying Taxes and Adjusting Withholding

One last suggestion doesn't involve a tax-lowering strategy, but rather the payment of income taxes themselves. For some taxpayers, the April deadline can be financially difficult in terms of paying what you owe on your federal tax return.

There are two actions that can help take the pain out of tax time. The first has to do with prepaying taxes. This is as simple as filling out a tax form, and sending the IRS a check to help cover your tax bill each quarter.

Correct Withholding

The second has to do with adjusting your withholding. Neither getting a large tax refund nor sending a large check to the IRS makes a lot of sense. If you're getting a large refund, that means you're lending the federal government your money - interest free.

On the other hand, if you're in a situation where you owe a lot of money to the IRS each year, that is not a good place to be either. In fact, withholding too little in taxes could expose you to unnecessary penalties.

If you're in either of these situations, then it's time to adjust your withholding. This process involves filling out a fairly simple tax form that you can download from the IRS website or get from your employer. The W-4 takes about ten minutes to complete, and filling out the form now may save you a big tax bill later on.

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