With the holiday season looming, it’s not too soon to do your year-end tax planning. One of the consequences of achieving financial success is that, what was once a relatively straightforward tax return increasingly becomes more involved as more tax issues come into the picture. You may have more transactions to track and forms to file. You also may also experience “bracket creep” which can suddenly change the way you manage your taxes and finances.
Waiting until tax filing time to deal with these issues could be hazardous to your wealth. As your finances improve, it is important to become more knowledgeable about your taxes to avoid any surprises.
The tax code is loaded with many provisions, big and small, that impact the financial lives of most Americans. Having some understanding of the intricacies of the taxation process can save a lot of time and money. Tax filing time should be used as an opportunity to assess where you are financially and prepare for the year to come.
Here are some tax planning steps you can take right now to keep you ahead of the game:
1. Beware of Bracket Creep
Not all income is taxed equally. Everyone begins the year in the lowest marginal tax bracket of 10%. As more income is received, it begins to spill over into higher marginal brackets – 12%, 22%, 24%, 32%, 35%, and ultimately, 37%. For example, if your maximum tax bracket has been 24%, it’s important to confirm whether an earnings increase will push you to the next bracket. If it does, not only will you be paying more taxes on the additional earnings, you will be paying it at a higher rate. And, don’t forget your state’s tax brackets (if your state has an income tax). They can creep even faster.
2. Manage to Your Adjusted Gross Income
Your tax bracket is determined by your Adjusted Gross Income (AGI). AGI is a function of your total income, including earnings, interest and capital gains, less deductions. The goal is to increase your earnings from one year to the next while keeping the tax you pay as low as possible.
For example, if your AGI last year was $120,000, and this year you earned an extra $5,000 of income, you could keep your AGI steady by making a $5,000 contribution to your qualified retirement plan (if you are eligible). If you plan to itemize your deductions, you might also consider a donation to charity if you are so inclined.
3. Accelerate Deductible Expenditures
Another way to manage your AGI is to pay any deductible expenses this year instead of next. For example, you could make your semi-annual property tax payment on December 31 of this year and claim it as a current year deduction.
4. Accelerate Business Expenses
If you’re a business owner, accelerating your business expenses can have the same effect as accelerating your personal deductible expenses. Consider pre-paying invoices, subscriptions, trade dues, legal fees, career education, and licenses this year. If run your business on a cash-basis, delaying receipts into January to reduce your business income enough to keep your AGI down.
5. Buy Your Tax Preparation Software Early
If you are trying to manage your year-end tax planning, it would be a great idea to purchase your tax preparation software now instead of waiting until tax season. This would enable you to input your numbers (based on estimation) now and begin modeling your tax moves between now and the end of the year. This can help you more accurately determine which moves to make to minimize the tax bite come April 15th.
If you have questions about year-end tax planning, we encourage you to talk to a financial advising team.