Income tax planning involves using strategies to minimize your taxable income. There are several different things that you can do you reduce the taxation of your income. Including, but not limited to; postponing income, shifting income, deduction planning, investment tax planning, and utilizing year-end tax planning. In this article, we will briefly go over how you can use each of these strategies to lower you tax liability.
- Delaying Income
This income tax planning strategy involves delaying your income to a later year. This way you can delay paying taxes on your income until you are in a lower tax bracket and will be liable for a smaller percentage of your earning. One of the methods you can use to delay taking your income is retirement accounts. Certain retirement accounts such as 401Ks and IRAs allow you to put away your pre-tax income and allow it to grow tax-free. Speak with a professional who specializes in both investment and tax planning to find out which type of investment would work best for you.
- Shifting Income
Another income tax planning strategy that you may wish to utilize is shifting income to another family member. Doing this allows you to lower your overall tax burden. One example of this would be gifting dividend producing stocks to your children. By doing this, you shift the income from you to your children. If you decide that this type of planning would be beneficial for you, it is important that you are aware of how kiddie tax laws may affect this.
Another income shifting strategy is available for those who own family businesses. Hiring a family member as an employee is a simple and effective way to transfer some tax liability to another person.
- Deduction Planning
It is extremely important that you take advantage of all the deductions that you are entitled to and time their use properly. You will have to decide whether taking the standard deduction or itemizing your deductions will be more beneficial for your situation. If you choose to itemize it is important to note that some deductions are only usable if they exceed a certain percentage of your adjusted gross income.
If you find that you are going to be in a high tax bracket this year, or you are going to owe a lot of money to the IRS, you may want to accelerate some of your deductions into the current year. This would mean paying expenses that are deductible and making charitable contributions.
- Investment Tax Planning
An area of income that you do not want to forget about is your investment income. You want to invest in such a way that will not generate large tax bills. This would include investing in tax-exempt securities and strategically timing the sale of capital assets.
If you have investments that are not tax-exempt, long-term capital gains tax rates will be important for you. These tax rates are much lower than your ordinary income tax rates. To be able to use the lower rates you must hold onto an investment for at least a year. We see too often that most brokers do not consider your income tax planning strategy while managing your investments. Consider an advisor that is a specialist in income tax planning as well as investment management.
- Year-End Tax Planning
Year-end tax planning is the process of determining what your tax liability is going to look like for the year. If you find that you are going to owe a large amount you will still have time to take action to try and reduce your liability either through postponing income or accelerating your deductions.
Overview
Income tax planning can be very complicated and incorrect planning could result in you owing a lot of money. If you are uncertain regarding anything related to tax planning, be sure to seek out a professional who is well versed in both tax and financial planning. They will be able to help you make decisions and reduce your tax liability while maximizing profits.