Tax Planning: What Is It Good For? The very last thing on most people's minds during the holidays is tax planning. But planning your taxes now can save you money on your tax return and potentially make you money on a refund! You may not plan on filing your tax return until April (find out what happens if you don't file you're tax return), but you only have until December 31st to make sure you qualify for many tax-saving deductions and– even better– credits.
Don’t get distracted by the holiday rush. Make sure you meet all the applicable requirements before December 31, so you can pay less tax in April.
What Is Tax Planning?
It is the creative process of organizing for and taking advantage of all the deductions and credits you plan to take on your tax return.
Think of tax planning as a money saving toolkit. All of our tools fall into two general categories: deductions and credits.
Tax deductions (and tax exemptions) reduce the amount of your income that is subject to taxation. The amount of the deduction is subtracted from your tax liability. Therefore, the actual value of a tax deduction depends on your tax rate. For example, if you are in the 25% tax bracket, a deduction of $1,000 would be worth $250.
Credits are worth much more money than deductions. Credits reduce the amount of taxes you owe dollar for dollar, and they come in two varieties: refundable and non-refundable. Most of the available credits are non-refundable, and they can reduce your tax liability to zero, but not further.
However, if your tax debt is zero after applying deductions and credits, any remaining refundable credit amount will be paid to you in your tax refund. Be sure to register with the IRS for direct deposit to get your refund in the shortest possible time.
Where Do I Start?
It is imperative to start with organized record keeping. Keep everything related to taxes: receipts, cancelled checks, paycheck stubs, bank statements, credit card bills, medical bills, etc. The IRS recommends keeping tax records for 3 years (4 years if you’re running a business).
It’s a good idea to scan your hard copies. This will make for easier referencing when it comes time to fill out your tax return and invaluable should you ever get audited.
Editor's note: Be sure to check out my article on How Long to Keep Your Financial Statements.
How Can I Save on Taxes?
1. Check your paycheck withholding! If you expect a tax refund, why wait until then to get your money? Any withheld money in your refund is just the repayment of an interest-free loan you made to the government.
2. Did you buy a home during 2009? Still planning to buy one soon? There is an $8,000 tax credit for first-time buyers and a new $6,500 credit for previous homeowners.
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3. Did you lose your job? Looking for a new job? Up to $2,400 of unemployment compensation is tax free. Job hunting expenses are deductible and so are the costs of moving to be closer to a new job.
4. Planning to retire? Contribute now and save on taxes. The Saver's Credit (formerly the Retirement Savings Contributions Credit) might be right for you. Also, it might be beneficial to convert your traditional IRA to a Roth.
5. Do you have children? Exemption amounts for dependents have increased, and so has the Adoption Credit. You might also reduce your tax burden with the Child Tax Credit and the Child and Dependent Care Credit.
6. Do you pay tuition for yourself or your dependents? Deduct $4,000 from taxable income for tuition and fees or claim the $2,500 Hope Credit (now known as the American Opportunity Credit).
7. Do you donate to charity? Charitable contributions of cash and property are traditional ways to reduce tax liability and they are still effective, but donating appreciated stock will allow you to deduct the full value of the stock while also saving you from paying capital gains tax on it.
8. Did you spend more than 7.5% of your income on medical expenses? It is worth keeping track of, because you can reduce your taxable income by that amount, as long as you kept the records to prove it.
9. Did you buy a car this year? If so, you’re in good shape. If you are considering it but haven’t bought one yet, you may want to reconsider and buy it before the end of the year. You can deduct the sales tax you pay on up to $49,500 of a new car’s price in 2009. In addition, you can deduct your personal property taxes. If your new car is a hybrid, you can also claim the Alternative Motor Vehicle Credit.
These tips are only the beginning! Learn about these breaks and so many more ways to save on taxes.
This is a guest post from Carl Forbes from Efile.com. You can email Carl at firstname.lastname@example.org.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute specific individualized tax, legal or investment advice. We suggest that you discuss your specific tax issues with a qualified tax or legal advisor.