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Taxes can have a major impact on your financial and investing plans. Planning ahead for these costs can make your financial plan much more tax efficient. While many people only think about taxes when they’re filing in the spring, tax planning should be a year-round matter, since all financial and investment decisions you make have a tax impact – even if that impact won’t be felt right away. In this article, we’ll go over some steps you can take to reduce your tax bill and take taxes into account as you make your financial plan.

Timing is Everything

Timing can make a big difference when it comes to your year-end tax bill. When you sell assets or pay your debts can make a big difference.

If you look at the investments in your non-retirement accounts at the end of the year, and see which investments are winners and losers, you might want to decide whether to sell these winning or losing investments. Selling those investments can affect your tax situation for the year.  You can use up to $3,000 in short-term losses to offset up to $3,000 of regular income each year. However, you can carry forward unused short-term losses for future use. Figure out which of the investments in your portfolio you want to sell now or later, depending on how it will affect your present and future tax plans.

There are other ways to plan ahead for spending that can help you reduce your tax bill. Charitable contributions can affect your tax bill as well. If your charitable giving doesn’t typically push you above the standard deduction amount, you might want to consider bunching deductions. That essentially means you donate several years’ worth of charitable gifts in a single year, which ends up pushing you above the threshold so you benefit from itemizing your deductions. A tax attorney or another financial professional can help you figure out how to time your giving and how to plan for that.

Planning Ahead

It’s a lot easier to have good timing when you plan. An advisor can help you figure out the right timing, but they can also help you stay aware of how your personal financial choices affect your tax plan. In addition, they can help you figure out all of the tax considerations you need to take into account for your financial and investment decisions ahead of time. And if you’re working with them year round, they can let you know when emerging tax issues call for changes in your financial plans.

Remember to document your financial decisions throughout the year. In other words, save your receipts. When you complete your tax return, you get to choose between the standard or itemized tax deduction to determine your taxable income. The standard deduction is a dollar amount that the government sets. You can claim the standard deduction without any additional accounting or evidence.

However, you may find that your actual deductible expenditures end up being more money than the standard deduction amount. If that’s true, you’ll be able to pay less in taxes if you use the itemized deduction method. To claim an itemized deduction, you’ll have to use other receipts and documents to prove you spent the amount of money you claim on tax-deductible expenditures.

Come up with an organizational system that works for you and begin saving receipts that can document potentially tax-deductible expenditures. You’ll want to save your receipts even if you claim the standard deduction. That way, you’ll be able to make an informed choice about which method will save you more money when you file your taxes.

Determine what tax bracket you are in. The federal government maintains seven brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%.

Federal Income Tax Bracket for 2019 (filed in April 2020)

Single Married Filing Jointly Married Filing Separately Head of Household
10% $0 – $9,700 $0 – 19,400 $0 – $9,700 $0 – $13,850
12% $9,701 – $39,475 $19,400 – $78,950 $9,701 – $39,475 $13,851 – $52,850
22% $39,476 – $84,200 $78,951 – $168,400 $39,476 – $84,200 $52,851 – $84,200
24% $84,201 – $160,725 $168,401 – $321,450 $84,201 – $160,725 $84,201 – $160,700
32% $160,726 – $204,100 $321,451 – $408,200 $160,726 – $204,100 $160,701 – $204,100
35% $204,101 – $510,300 $408,201 – $612,350 $204,101 – $510,300 $204,101 – $510,300
37% $510,301+ $612,351+ $510,301+ $510,301+

Federal Income Tax Bracket for 2020 (filed in April 2021)

Single Married Filing Jointly Married Filing Separately Head of Household
10% $0 – $9,875 $0 – $19,750 $0 – $9,875 $0 – $14,100
12% $9,876 – $40,125 $19,751 – $80,250 $9,876 – $40,125 $14,101 – $53,700
22% $40,126 – $85,525 $80,251 – $171,050 $40,126 – $85,525 $53,701 – $85,500
24% $85,526 – $163,300 $171,051 – $326,600 $85,526 – $163,300 $85,501 – $163,300
32% $163,301 – $207,350 $326,601 – $414,700 $163,301 – $207,350 $163,301 – $207,350
35% $207,351 – $518,400 $414,701 – $622,050 $207,351 – $518,400 $207,351 – $518,400
37% $518,401+ $622,051+ $518,401+ $518,401+

Put Money in Tax-Advantaged Holdings

You might want to talk to an advisor about which of these tax-advantaged holdings would work for you, and how much you should be putting in them to lower your tax bill.

Tax-Advantaged Retirement Accounts

You can reduce your taxable income by contributing to a retirement plan. If you are under the age of 50, you can contribute up to $19,000 a year to a 401(k) and up to $6,000 a year to an IRA. Starting at age 50, you can begin contributing up to $25,000 a year to a 401(k) and $7,000 a year to an IRA.

The money you contribute and the earnings you make are tax-deferred until you make withdrawals. That means you can deduct the amount you contribute to your IRA or 401(k) from your taxable income, and do not pay any tax on that money until you withdraw it. However, if you are covered by a retirement plan like a 401(k), you may not be permitted to deduct your IRA contributions from your taxable income.

Remember to look into a Roth IRA or a Roth 401(k) plan as well. Although contributing to these accounts will not reduce your taxable income for that year, it may end up reducing your overall taxable income. Although the money put into a Roth account is after-tax dollars, the gains you make in Roth accounts are not taxed when you draw from that money in retirement.

529 College Savings

If you have a child or are helping save for a family member’s college, you should consider contributing to a 529 college savings account before the end of the year. Although these contributions are not deductible for federal taxes, over 30 states and the District of Columbia offer a full or partial deduction or credit for contributions to a 529 plan.

ABLE Account

An estimated 20 percent of households with children under 18 are estimated to have a child with special needs. Those with special needs and their families can contribute up to $15,000 a year into an ABLE account. The limit is even higher if the person with the disability is working and does not participate in a workplace 401(k) or other retirement program.

Money is put in after taxes are paid, and earnings growth and qualified withdrawals are tax free. In addition, states allow you to deduct your contribution to this savings program. In Massachusetts and other states, there is no minimum to open the account and no annual maintenance fee.

Use Tax Credits

You may be eligible for certain tax credits. Refundable tax credits will not only lower your taxes but can be used to create a surplus, which can get you a refund.

Some refundable tax credits include:

The American Opportunity tax credit

  • Individuals who pay for college or university for themselves or other qualifying individuals may be eligible for this tax credit. In 2019 you could get up to $2,500 per qualifying student. Fully 40 percent of this tax credit is refundable.

The child tax credit

  • You may be eligible for this credit if you have qualifying dependent children under the age of 17. You could get up to $2,000 in 2019 with this tax credit.

The child and dependent care tax credit

  • You may be eligible for this tax credit if you must pay for childcare or care for disabled dependents.

The earned income tax credit

  • Low-income earners may be eligible for this credit. Your eligibility will depend on your earnings, filing status and the number of dependent children you have.

The Bottom Line

Aim to start planning for your taxes as soon as that tax year begins instead of scrambling at the last minute in April of the next year. That way you can begin to document all of your deductible expenditures and figure out which tax credits you may be able to take early on. If you haven’t kept all your receipts, you can still start on your taxes early, figure out what tax credits and retirement accounts might help you save money and start documenting potentially eligible expenditures in 2020.

Tips

  • Consider talking to a financial advisor about fully incorporating tax planning into your personal financial planning. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
  • If you usually owe a lot in taxes at the end of each year and it’s a stressor on your wallet, you may want to adjust the withholding amounts on your W-4 so you can budget better throughout the year and pay less in taxes when April rolls around.

Photo credit: ©iStock.com/designer491, ©iStock.com/mediaphotos, ©iStock.com/kate_sept2004

Sarah Fisher Sarah Fisher has been researching and writing about business and finance for years. She has worked for the Consumer Financial Protection Bureau and her work has appeared on Business Insider and Yahoo Finance. Sarah has a bachelor's degree from Georgetown University and is from New York City. When she isn't writing finance articles, she dabbles in animation and graphic design.
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