Transform Your Finances: Start Tax Planning Today
The tax deadline marks an important date for millions. We all want a good outcome and in order to achieve that we need to do some tax planning. The IRS issues tens of millions of refunds a year for taxpayers that have overpaid taxes throughout the year. In 2019 these tax refunds averaged $3,068. While many Americans look forward to these refunds, most financial professionals consider tax refunds as an absolute waste of money. They argue that the perfect number to see on a tax return is zero. Why? This means you have paid the correct amount of taxes during the year. A tax refund may not be ideal because this is money that you could have received through out the year. Instead the IRS keeps it and you don’t earn any interest. You also don’t want to owe too much because you could end up getting penalized for underpayment. Whatever result you want from your tax return, the only way to get your desired outcome is through tax planning.
How Do I Start Tax Planning?
The goal of tax planning is to estimate the coming year’s taxes and to maximize tax efficiency. In order to begin planning your taxes, you need to have some understanding of how taxes work. While you don’t need to become a tax expert, you should understand your current tax bracket. It is well understood that the more you earn the more taxes you have to pay. Most taxpayers do not understand that you don’t pay one flat tax rate on all of your income. Check out our blog and video explaining tax brackets: https://molentax.com/how-do-tax-brackets-work/.
Understanding Your Taxes
First, there are deductions that you can subtract from your salary to determine your taxable income. Second, your taxable income is taxed in chunks beginning with the 10% bracket, and capping at the 37% bracket. It is also important to understand what deductions and credits you plan to report. The standard deduction for a single filer in 2020 is $12,400 and is a reduction to taxable income. Credits such as the $2,000 Child Tax Credit is a dollar for dollar decrease in taxes owed for the year. Once you know what to expect on next year’s taxes, you can begin implementing strategies to cut down on taxes.
https://molentax.com/how-to-save-on-taxes/
Fix your W-4!
Getting a larger refund is as easy as giving the IRS more money from each paycheck! President Donald Trump signed the Tax Cuts and Jobs Act to change the tax law for 2018 and later tax years. He boasted an extra $40 increase in each paycheck to the average American worker. While the tax cuts did help certain taxpayers have a lower tax burden, the way Trump increased our paychecks was by decreasing everyone’s tax withholding. Unfortunately, taxpayers who owed in 2017 found an even higher tax bill in 2018 because they had less money coming out of each check for taxes. The IRS redesigned the 2020 W-4 to try to reduce the form’s complexity and make the withholding system more accurate. You do not have to submit a new W-4 if you want the withholding to stay the same.
W-4 Step by Step
Step 1: Enter your personal information, and what filing status you plan to file as.
Step 2: If you are single and have only one job, or you are married but only one of you works a single job skip this step. If you and your spouse work, or single with multiple jobs, you can use the Step 2b worksheet on page 3 or check the box on 2c. This box should only be checked to increase your withholding when there is a second job at a similar income level.
Step 3: Enter $2,000 for children under 17, or $500 for dependents over 17 in order to decrease the amount of money withheld from each check.
Step 4: I advise leaving Step 4 blank when you first submit a 2020 Form W-4. If you have specific changes you want to make from your original 2020 Form W-4, use the following tools.
4a is a tool to increase your withholding to compensate for other income.
4b is a tool to decrease your withholding because you plan to have less taxable income.
4c is a tool to make a dollar amount increase in the amount of money taken out of each check for taxes.
Step 5: Sign and date
Don’t Pay Taxes on Health Expenses
Take advantage of your employer FSA or HSA. A flexible spending account lowers your taxes each year by using pre-tax dollars from your paychecks. These can be used on most medical expenses from prescriptions, dental care, and vision. When you decide how much money you want to put into an FSA, you have to keep in mind that you use it, or you lose it. A health savings account is tax deductible, grows tax free, and the funds can be used tax free. In order to qualify for an HSA account, you need to be enrolled in a high deductible health plan. Like an FSA, an HSA must be used on qualified medical expenses to avoid paying taxes on that money. Unlike an FSA, money put into a health savings account can be left to grow overtime and can be taken out at retirement penalty free if you choose to pay taxes on the money.
Use Tax Planning & Bulk up your Retirement!
It is common knowledge that retirement accounts have tax advantages, but few Americans save enough to retire comfortably. Even fewer truly understand what tax advantages retirement accounts offer. Most salaried employees are given the option to put money from each paycheck into a deferred compensation account such as a 401k plan. By deferring some amount of money from each paycheck, you get to save for retirement while saving on taxes! Another key advantage to a deferred compensation account is tax free growth. Unlike a money market account, you will not be issued a tax form each year for earnings on stock sales, interest, and dividends. If you follow the rules and leave the money in your account until retirement, you will be able to take out this money and pay taxes on it at that time. Alternatively, a designated Roth 401k does not give you a tax break when you contribute, but the withdrawals and earnings are tax free. Check out my blog on the subject for more information https://molentax.com/401k-versus-ira/.
Tax Planning with Molen & Associates
The IRS considers lying on your tax return to be tax evasion. They will penalize those who cheat on their taxes to the full extent of the law. Tax avoidance, on the other hand, is the legal alternative to saving on taxes and requires tax planning. The strategies in this article are by no means all inclusive, and the right strategy for each taxpayer is different. At Molen & Associates we solve tax headaches for a living and will be happy to personalize your tax planning to best fit your individual needs.
Austin Long
Tax Advisor, EA
