Tax planning is complicated and confusing for many taxpayers. The U.S. tax code is always changing, and new regulations, revenue rulings, and court cases are always popping up. It’s important to ensure you’re prepared for the upcoming tax season. The small tax planning tips below help you understand your tax liabilities and come up with strategies to reduce your overall taxes and save and invest your resources.
In this post, we highlight some essential tax planning tips for beginners. Whether you are starting your own business or have been in business for a while, following these tips will help you maximize your deductions.
#1. Tax Bracket Doesn’t Apply to Total Income
Irrespective of the tax bracket you fall in, your total income or salary is never taxed at the same rate.
The United States currently has seven federal income tax brackets, with rates of 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Even if you fall in the 37% bracket, your entire income is not subjected to a 37% tax.
Let’s say you are a single status taxpayer with $280,000 taxable income per year. This means you fall in the 32% tax bracket. You will have to pay 10% on the first $9,875, 12% for the next earnings up to $40,125, 22% for the next earnings up to $85,525, 24% for up to $163,300, $32% for up to 207,350, and 35% on the remaining income.
In this case, you would be paying $56,519 on your total taxable income $280,000. Therefore, your effective tax rate would be 20.18% (56,519 / 280,000) where as your marginal tax rate would be 37% in this case.
You may find yourself getting over to the next tax bracket, and it may be prudent to plan increasing expenses or deferring income by contributing to retirement account to avoid extra tax payments. Knowing which tax bracket you will fall before the year end is the first step to pay less taxes.
#2. Tax Deductions And Credits Are Not The Same
Some taxpayers are not familiar with the difference between tax deductions and tax credits. While tax deductions reduce your taxable income, tax credits directly offset your tax liability dollar-for-dollar. Tax credits are designed to motivate business owners to reinvest in specific ways such as Premium Tax Credit, Small Employer Health Insurance Premiums Credits, Retirement Plan Startup Costs Tax Credit, Work Opportunity Tax Credit, Rehabilitation Tax Credit, etc.
Both tax deductions and tax credits reduce your tax bills, but if you have options to choose either credit or deduction, it’s likely you are better off choosing credit.
#3. Opting for Standard vs. Itemizing Deductions
Standard deductions are fixed deductions, and the amount depends on your filing status, such as single, married, head of household, etc.
On the other hand, itemized deductions are for those whose allowable expenses such as medical expenses, state and local taxes, mortgage interest, charitable donations are greater than the standard deduction.
For instance, this 2020 year, the standard deduction for married taxpayers filing jointly is $24,800. If a married couple has allowable itemized deductions greater than $24,800, choosing itemized deductions will lead to smaller taxable income.
Watch out for charitable contribution for taxpayers choosing standard deduction for 2020. The congress passed Cares Act that allows up to $300 above-the-line deduction for taxpayers in 2020 (charitable contribution was deductible only through itemized deductions).
Expert Tax Planning Services in Tigard, Oregon – Hoshi CPA LLC
We are proud to offer expert tax planning services to business owners, executives, and independent professionals in the Tigard area. Our proactive approach, combined with our experience and in-depth knowledge, offers you a long-term tax plan that keeps finding opportunities to lower your tax liabilities.
Have any questions about what we can do? Please call us at (503) 388-6580 or reach out via our contact form. We are the best CPA firms in Tigard, Oregon. We’re always happy to empower people who are looking to take control of their tax situation.
