6 Steps to Take Now to Save Money Next Tax Season

Now that tax season is over, we all can relax a bit. As a financial advisor and tax preparer, I am reflecting on advice that I wish I could've given my clients earlier last year that would've produced more favorable outcomes. The tax code is complicated and the difference between receiving a credit and not can be due to a threshold missed by a few dollars. Also, I have seen clients that would have qualified for an exception on an IRA deduction the previous year but not in the current when the withdrawal was made, or just miss the opportunity to take the student loan deduction because there income was $500 dollars above the limit. This is why tax planning is so important. Many of us pay around 30% percent of our income on taxes and it is our largest expense. We should be managing taxes as aggressively as we budget and control other expenses. Paying tax is inevitable but we can definitely try to save where we can. Here are some tips to help get you on your way to a more favorable tax situation for next season!

1) Know your tax bracket and deduction and credit cut offs.

2019 individual rate brackets

Work through some what if scenarios with your tax advisors to see what bracket you are in and what credits/deductions you qualify for. If there you are at the cutoff, you can use various strategies such as bunching, utilizing retirement plans, or planning for business purchases to reduce your income.

2) If you are an employee make sure you are taking the correct number of exemptions. If you are self employed make your estimated tax payments.

It is important to know how much your tax liability is and be sure to be taking the correct number of exemptions on your W-4 if you are an employee. You don't want to overpay taxes throughout the year, leaving yourself with less money to spend or save, but you also don't want to underpay and end up owing money you may not have.  There is a guide on the IRS website that will help you figure out the withholding amount that is right for you.  Click here if you would like to check it out. If you are self employed it is important to keep accurate financial records and make estimated tax payments throughout the year to avoid penalties and a large payment due at year end.

3) Know how life changes affect your taxes

Getting married, having a baby or changing jobs? Be sure to consider how your life event will will affect your taxes and steps you can take to minimize your tax liability. If being married puts you in a higher tax bracket, consider buying a home to qualify for interest deductions. Max out your 401k  since you should have some extra cash from sharing expenses.  If you are having a baby find out if you qualify for child tax credits and check your employers benefits package for dependent care benefits offered. If you are changing jobs be sure to find out about stock options, deferred compensation, retirement plans and other tax savings benefits available to you.

4) Avoid Making IRA withdrawals 

Most people don't realize just how expensive withdrawing money from an IRA actually is. There is a 10% penalty on withdrawals and the amount withdrawn is considered income in the current year, typically putting you in a higher tax bracket.  For example, if you are married and make $200k a year and you take out $50k from your retirement account, you will pay 32% tax on the  withdrawal in addition to a 10% penalty.  In total you are paying $21k which would be over 40% of the withdrawal in federal taxes, not to mention state taxes. Couple that with the interest you may end up paying the IRS if you don't pay the tax right away, you could end up getting less than half of your withdrawal in the long run.  You are also missing out on the opportunity for those funds to grow over time.  Consider other alternatives such as a home equity loan and making sure you build an emergency fund that is readily available before you max out your 401k. If you need money for an emergency and the absolute last resort is taking money from your retirement accounts, find out if you can you qualify for an exception so you don't have to pay the penalty. Below are qualifying events for an IRA withdrawal.

• You use the withdrawal (up to a $10,000 lifetime maximum) to pay for a first-time home purchase 
• You use the withdrawal to pay for qualified education expenses.
• You become disabled
• You use the withdrawal to pay for unreimbursed medical expenses or health insurance if you’re unemployed.
• The distribution is made in substantially equal periodic payments under IRS code 72t

5) Plan for taxes on the sale of assets.

Can you live in house to qualify for gain exemption? When selling your primary home if you owned and lived in the place for two of the five years before the sale, then up to $250,000 of profit is tax-free. If you are married and file a joint return, the tax-free amount doubles to $500,000. If you are selling a rental property to purchase another, look into doing a 1031 exchange to save on taxes from the gain on the  sale.

6) If you own a business and don't have time to take care of finances, hire a bookkeeper or accountant!

I have seen many cases where people don't know what they spent on their business throughout the year, it becomes overwhelming, and they just put off filing taxes. Doing this will end up costing much more than a bookkeeper because  you will owe interest on the amounts owed  and penalties for not making quarterly payments. Not to mention the stress and lack of ability to plan or get a business loan.  If you have a profitable business you are in an ideal position to save on taxes. Take advantage of it by hiring professional help!