The “What” and “How” of Tax Planning for Dummies

The winter snow is starting to melt and the warm weather is starting to shine through. This means it’s time to start thinking about spring cleaning, outdoor adventures, and, you guessed it- taxes.

Taxes are due on April 15th, and while that may feel like a ways away, you can never start tax planning too early. What is tax planning? Why do you need to do it? How do you do it?

Check out this guide to learn everything you need to know about tax planning.

What is Tax Planning?

Tax planning involves organizing and analyzing your financial documents from the past year so you can maximize tax breaks and minimalize tax liabilities. In other words, tax planning helps you save money and stay out of trouble.

Tax rules can be complicated (there’s a reason so many people hire an accountant to do their taxes), so giving yourself enough time to understand your yearly finances is very important.

Tax Planning Strategies

If done right, tax planning can help you grow your income and prepare for the road ahead. Here’s what you need to do to plan for Tax Day:

1. Understand Your Income Bracket

You can’t plan for your financial future if you don’t know where your finances are today. This means you should begin your tax planning strategy by understanding what federal tax bracket you fall into.

The US has a progressive tax system, which means the more money you make, the more you’re taxed. Depending on how much you make, you may be taxed anywhere from 10 to 37 percent of your income. You can learn more about your tax bracket here.

However, keep in mind that you get to subtract your deductions, so you likely won’t need to pay the full rate.

2. Understand the Popular Tax Deductions and Tax Credits

If you want to save money on your taxes this year, then you need to familiarize yourself with the popular tax deductions and tax credits. But first, you need to understand the difference between a tax deduction and tax credit.

A tax deduction is an expense that you’ve incurred that you can subtract from your taxable income, whereas a tax credit is a dollar-for-dollar reduction that you can get on your tax bill. For example, if you get a $500 tax credit, that’s $500 off your total tax bill.

Here are some popular tax deductions:

  • Medical and dental expenses
  • Charitable contributions
  • Sales and property taxes
  • Business-related expenses (for example, using your home as your business)

Examples of tax credits include:

You should look into each of these separately to see if you qualify.

3. Contribute to Tax-Deferred Retirement Accounts

One of the best ways to invest your money is to contribute to a tax-deferred retirement account. These accounts are tax-free and compound over time, meaning they can grow to a substantial sum.

Consider increasing your 401(k) contributions and setting up an IRA if you don’t already have one. You can contact wealthability firms for advice on setting up these accounts.

Time to Start Tax Planning

Now that we’ve answered the question, “What is tax planning?”, it’s time for you to put these strategies to use. While tax planning can take a lot of time, it’ll help you make the most of your money.

Be sure to check back in with our blog for more tax preparation tips!

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