“Planning is bringing the future into the present so that you can do something about it now.” ~ Alan Lakein
Tax planning is a concept which has become a more prevalent topic in American’s lexicon since the passage of the Tax Cuts and Jobs Act, which became law in December of 2017. Tax planning is the analysis of your financial situation from a tax perspective and has several beneficial advantages that can help you leverage tax benefits, preserve investment returns, structure charitable donations, protect and secure financial support for dependents, and prepare for a secure retirement. If you’re looking to reduce your taxes or increase your tax refund for 2020, here are some tax planning basics to follow.
What is Tax Planning?
Tax planning is all about tax efficiency. When done correctly, tax planning leaves you with a financial plan that ties together all the elements of your economic life, ensuring that you minimize your tax liabilities and help with after-tax wealth accumulation. Common considerations of tax planning include your income, coupled with planning the timing of purchases and expenditures. Tax planning also involves using strategies that allow you to save for retirement and utilizing different types of tax shelters. While tax planning can be confusing and seem like a daunting task for those just getting started, you can simplify the process by keeping a few key concepts in mind when beginning your tax planning.
Know Your Tax Bracket
For tax planning starters, understanding the progressive tax bracket your income level falls into is paramount. In all, there are now seven federal income tax brackets. To discover which tax bracket you fall into, you take your entire income for the year, then subtract tax deductions to determine your taxable income. You then divide your taxable income into parts and then pay taxes on each piece. For example, if you earned $50,000 for the year, you would pay 22% on the first $39,475 and then 12% on the remaining $9,700. The table below shows the tax brackets and rates for 2019.
| Rate | Unmarried Individuals, Taxable Income Over | Married Individuals, Taxable Income Over | Head of Household, Taxable Income Over |
| 10% | $0 | $0 | $0 |
| 12% | $9,700 | $19,400 | $13,850 |
| 22% | $39,475 | $78,950 | $52,850 |
| 24% | $84,200 | $168,400 | $84,200 |
| 32% | $160,725 | $321,450 | $160,700 |
| 35% | $204,100 | $408,200 | $204,100 |
| 37% | $510,300 | $612,350 | $510,300 |
Understand Tax Deductions and Tax Credits
First-time tax planners tend to focus solely on obtaining tax deductions while ignoring tax credits. The difference between tax deductions and tax credits is that a tax credit is applied to the amount of taxes you owe, while a tax deduction lowers your overall taxable income. Both deductions and credits can reduce your tax liability, but they do it differently and could make the difference in a large amount of money. Tax deductions include things such as:
- Mortgage Loan Interest
- Medical and Dental Expenses
- School Tuition and Fees
- Contributions to IRA or health savings accounts (HSAs)
- Unreimbursed business expenses and business travel mileage
- Property and Real Estate Taxes
Tax credits include items such as:
- Lifetime Learning Credit (College Education Cost)
- Premium Tax Credit
- Child Tax Credit (Being a Parent)
- Adoption Credit (Being an Adoptive Parent)
- Child and Dependent Care Credit (Day Care and similar costs)
- Saver’s Credit (Contribution to IRA for certain income levels)
- American Opportunity Credit (College Education Cost)
Both deductions and credits can help lower your tax liability, which is why tax planning is so crucial. With an appropriate amount of tax planning, you’ll be able to design your spending and saving habits in a way that optimizes your tax efficiency.
Keeping track of your deductions throughout the year via a finance app, spreadsheet, or accounting software can help you quickly compare your itemized expenses with your standard deduction and decide which will be best to use.
Decide between Itemized Deductions and Standard Deduction
Speaking of deductions, deciding which you will use is another vital aspect of tax planning. You’ll have to determine if you will either use the standard deduction, which is a flat rate dollar amount that you can subtract from your income tax, or the itemized deduction, where you deduct each eligible expenditure from your income tax. The initial decision between the two rests on which will offer you the most significant amount of deductions. For example, if you itemize your mortgage interest and property taxes, and they add up to be a more substantial amount than the standard deduction, it makes sense to itemize your deductions. On the other hand, if you unmarried, don’t own property, and have no dependents, you’ll likely get a more significant decrease in tax liability from the standard deduction. Business owners often use itemized deductions as they spend a higher amount of money each year on items that qualify for tax deductions. The 2019 standard deduction and personal exemptions are as follows:
| Filing Status | Deduction |
| Single | $12, 200 |
| Married (Filing Jointly) | $24,400 |
| Head of Household | $18, 350 |
Consider Adjusting Your Tax Withholdings
For every paycheck that you earn, your employer will withhold a certain amount of income tax based on the Employee Withholding Allowance Certificate (W-4 form) that you filled out when initially hired. The amount of income taxes withheld depends on how many allowances you claim (0-9). The more allowances you claim, the less money will be withheld and visa-versa. Assessing your financial situation and previous tax returns may show that you receive a large amount of cash back on your income tax returns each year. If this is the case, adjusting your withholdings to a higher amount of allowances will place more money in your pocket every month that you can use to grow your income. Depending on your situation, you may wish to claim fewer allowances to avoid a tax bill at the end of the year. Consulting your CPA is wise before you adjust your tax withholdings.
Find Income Shelters or Tax Cuts
Seeking ways to shelter your income or decrease your tax bill is where tax planning truly begins. The idea is to make proactive decisions that will allow you to achieve your personal and professional goals. Some of the few ways that accountants and CPAs advise clients to achieve income sheltering or tax cuts include some of the following vehicles:
Participate in a 401(k) savings plan: if you work for a company that offers a 401(k) program, you can arrange for money to be placed into the account before taxes. Many financial planners and tax professionals recommend maxing out your annual 401(k) contributions as you can reinvest your earnings without paying taxes on them. You can start withdrawing money between 55 and 59 ½ without being penalized in most situations.
Utilize Health Savings Accounts (HSAs): So long as the funds are used for qualifying medical expenses, your HSA contributions are tax-deductible, and the withdrawals are tax-free. With this fact considered, maximizing your HSA contributions will allow you to save money on things such as medication and medical services not covered by your insurance.
Use Flexible Spending Accounts (FSA) and Dependent Care Flexible Spending Accounts (DCFSAs): Similar to HSAs, FSAs allow you to divert tax free dollars from your paycheck to be used for medical and dental expenses, and also cover other items like first aid supplies, over-the-counter medication, alternative drugs and medicines, and co-payments for medical, dental, vision, and prescription insurances. DCFSAs work the same by enabling you to reduce your tax bill while allowing you to use your DCFSA account to pay for preschool, day camps, after-school care, and even elderly care under some plans.
Tax Planning is What We Do
While tax planning is typically performed toward the end of the year, if you haven’t formalized a tax planning strategy, it’s never too early, or too late, to start. Meeting with a Certified Professional Accountant today can give you additional insight into tax planning and offer you the professional assistance that you need to ensure your tax plan starts on a firm foundation. At Lawhorn CPA Group, we help individuals and businesses form a tax plan that works best for their unique situation, help provide insight into financial statements, and create strategies to achieve their goals. Contact us online or at 865-212-4867 today to find out additional information about tax planning.