THE IMPORTANCE OF HAVING A TAX PLAN
WHAT IS TAX PLANNING?
The definition of tax planning is simple. It involves analyzing your financial situation so you can minimize your tax liability. It allows you to owe less and earn back more. At the end of tax season, it can result in hundreds or thousands of dollars in your pocket, depending on your situation. Tax planning is an essential part of any financial plan for individuals, families or businesses. Proper planning allows you to understand which tax benefits you qualify for. You might be able to take advantage of:
- Deductions: Tax deductions allow you to reduce your taxable income. They’re usually expenses you incur throughout the year, which you can subtract from your total income. A deduction might include a charitable donation.
- Rebates: Rebates are a form of a refund, which occur after a retroactive tax decrease. Congress sometimes offers rebates to help stimulate the economy during financial recessions. They’re also used to incentivize environmentally friendly practices.
- Credits: Credits allow you to subtract from the total you owe. If you’re a student, a low-income family or you have children, you may qualify for a tax credit.
- Concessions: A tax concession is a government reduction in the amount a certain group of people owes. They’re usually used to incentivize certain behavior.
- Exemptions: Exemptions reduce or eliminate someone’s responsibility to pay. Dependent-related exemptions allow you to reduce your taxes by a certain amount for each child or other relative under your care.
WHAT ARE THE DIFFERENT TYPES OF TAX PLANNING?
The four basic types of tax planning include:
- Federal income tax planning: It’s wise to plan your federal income taxes. Federal income tax deductions might include student loan interest, college savings and charitable donations. Credits might include a child tax credit, an earned income tax credit or an American Opportunity tax credit.
- Retirement tax planning: With proper planning, you can reduce your tax liability and maximize your income post- career. This involves best utilization of an individual retirement account or 401(k) plan and careful calculation of your Social Security benefits.
- Estate tax planning: When someone passes away, their estate may be subject to federal estate taxes. Those who fall into this category require estate tax planning to preserve their estate’s value. Some states also demand an estate tax, sometimes at lower value thresholds.
- Small business tax planning: Small business and self-employed workers have unique tax responsibilities. Applying the right deductions is critical. For instance, if you work out of a home office, you may be eligible for a deduction. You might also deduct the cost of vehicles, office equipment, travel and other business-related expenses. If you’re starting a new business, it’s important to take advantage of any tax relief.
WHAT ARE THE BENEFITS OF TAX PLANNING?
Tax planning has many short-term and long-term benefits. The main short-term benefit is more money in your pocket after tax season. Long-term benefits might include any of the following, depending on your situation:
- Solving tax issues: If you owe back taxes or have other tax issues, planning can help you address these concerns and find a solution.
- Building a college fund: Tuition costs have risen exponentially in previous decades. If you want to build a college fund for your child, you can take advantage of the American Opportunity Credit to help you minimize future education expenses.
- Supporting your business: Starting or sustaining a business is challenging for many reasons — tax liability need not be one of those reasons. With small business tax planning, you can boost your business and accumulate more resources for growth.
- Saving for retirement: Your retirement contributions can grow tax-free over time, resulting in a sizable nest egg for the future. Retirement might seem a long way off, but early planning is vital for a comfortable post-career life.
- Maximizing an estate: If you have an estate large enough to incur state or federal estate taxes, proper planning can make a notable difference for your family’s finances, reducing your liability.
- Securing more for your heirs: With thoughtful tax planning, you’ll have more to pass on to your heirs. You can also work to minimize your heirs’ inheritance tax liability, so they can keep more of your lifetime earnings.