Tax Planning How to Minimize your Tax Liability and Maximize Deductions

  1. With these seven tips, anyone can learn how to effectively reduce their tax liability and maximize their deductions. But it is important to remember that you can't have good tax planning without the planning. Once you become familiar with the basics and how to spot opportunities, the process will seem simpler and routine.

    Effective tax planning is a continuous activity.


    In order to minimize your tax payments and make the most of your income, you’ll need to take advantage of the opportunities that avail themselves all year round. You’ll want to keep track of the items that are discussed below and calculate your estimated tax periodically during the year. Doing so will help you can make timely decisions that can effectively reduce the taxes that you owe. This could include selling poorly performing stock resulting in a loss, waiting to sell your home, deferring a bonus, adding to a retirement plan or contributing to flex spending for medical needs. The timing of your taxable events may determine not only how much tax you owe this year but also in future years. You want to have plenty of deductions to take in years when your income is highest and not lose tax benefits that can be deferred during years of lower income. In order to make this happen effectively, you will need to conduct periodic tax planning all year round.

    Keep accurate, organized records.


    You can gather all your receipts and the notes that you wrote on dinner napkins from the shoe box and try to reconstruct your taxable events. But this doesn’t usually bode well in practice. It's more likely that you'll end up counting too few deductions and paying too much income taxes. If you're not naturally organized, do your best to make timely entries concerning your transactions in a notebook or a spreadsheet. Set aside time just one evening every month to be responsible! File your receipts and statements from banks and stock brokers conveniently. And remember to keep your records safe for up to six years after the date the tax return is filed in the event you need to deal with an audit.

    Use available itemized deductions, business expenses and tax credits.


    Itemized deductions and business expenses on your tax return act to reduce your adjusted gross income. Schedule A of your IRS Form 1040 includes personal, itemized deductions for health care expenses, charitable donations, mortgage interest, taxes (property, state and local), home office costs, employment seeking expenses and some others. While you may be better off with a standard deduction, you should always review the complete list of itemized deductions early in the tax year to determine whether it makes sense to take advantage of some of these benefits. The same approach should be taken in determining deductions for business expenses, which is listed in Schedule C of Form 1040. Business deductions include expenses incurred for advertising, use of an automobile, commissions and fees, depreciation, the cost of resold products, labor costs, rent and utilities, most insurance as well as business equipment (such as a phone, computer, peripherals and office furniture.)

    Tax credits are even more powerful than deductions in decreasing your tax liability. The credits taken directly against the amount of tax that you owe, dollar for dollar. Available credits include those for child and dependent care, college funds and other incentive based initiatives. Other tax credits are available for certain business activities and many for low income persons such as the EITC (Earned Income Tax Credit).

    Move income to non-taxable accounts and programs.


    Pursuant to Section 125 of the Internal Revenue Code (IRC), you can transfer income into a tax-free employee benefit plan known as a “cafeteria plan.” Contributions made typically result in pre-tax benefits. A flexible spending account (FSA) is commonly used for medical and health care, child care and other expenses such as transportation and parking. A health savings account (HSA) is also tax-free but limited to qualified medical and healthcare expenses. An HSA may be used to pay the deductible portion of healthcare services (doctor visits, lab tests and hospital visits.) A qualified education assistance program may also be available from your employer as another example of a non-taxable benefit. Also related are Education Savings Accounts (ESA) which help parents and students save and contribute money, tax-free, to provide for continued education such as a college plan.

    Make income contributions to retirement accounts.


    If you’re in a company that provides a 401k plan, you should consider making contributions. You can also sign up for an IRA (Individual Retirement Account) on your own. In both instances, the contributions made to your nest egg are tax free. Roth accounts work the other way around - contributions made are not given any special treatment. But withdrawals of those amounts and any investment earnings at retirement are not subject to federal and state income taxes.

    Report your income accurately and honestly.


    Make sure that your tax forms are filled out honestly and that they take a position that can be justified. The IRS recognizes that sometimes there are tax reporting errors made in good faith or that may have been inadvertently overlooked. If you owe additional taxes, you may be required to pay a small penalty. But if the IRS believes that you made efforts to willfully evade paying taxes such as failing to report income or to provide information, you could be subject to criminal charges. If you realize that you’ve made a material mistake later, you can file an amended return (Form 1040-X).

    File a tax return even if you don’t owe any income tax.


    If you don’t believe that you owe any income tax, it’s understandable to feel that you shouldn’t need to file a tax return. But there is a difference between filing a return and paying taxes. The IRS has guidelines with regard to who must file a return. Even if you don’t owe any income tax, you still may be required to file a return. The term “voluntary” that many cite comes from the notion that if you owe tax, you must “volunteer” a return - not that reporting or paying taxes are voluntary in nature. The failure to comply with rules for filing and paying income taxes can result in civil and criminal penalties. Even if you can’t afford to pay the amount owed when due, it is best to file and try to make arrangements with the IRS to deal with your hardship.

    Using software and professional help to minimize your tax liability.


    If you intend to use software to help with the preparation of your tax returns, make sure that it is produced by a reliable company. Perform research prior to any purchase. Using professional services such as an experienced, certified accountant will frequently provide excellent results. When an estate is involved, the use of a tax or estate planning attorney is highly recommended as mistakes can result in significant and unnecessary tax liability.

    Michael Wechsler

    Michael Wechsler
    Michael M. Wechsler is an experienced attorney, founder of TheLaw.com, A. Research Scholar at Columbia Business School and of-counsel to Kaplan, Williams & Graffeo, LLC. He was also an SVP and chief Internet strategist at Zedge.net and legal consultant at Kroll Ontrack, a leading service e-discovery and computer forensics service provider.

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