Beginner’s Guide to Tax Planning

Owning a small business can be exciting and challenging all at the same time. Between work and your responsibilities at home, your daily schedule is always packed. When tax season rolls around, you’re going to find yourself in an even tighter bind as you worry over how you’re going to file your taxes with everything else going on. Well, if you start planning your taxes now, you will save yourself time and energy as you won’t stress over them. Even so, you could change how much you end up paying and increase the amount you receive.

With most of us working from home due to the ongoing coronavirus pandemic, this is the perfect time for you to learn more about tax planning! Spend some time doing your own research and when you’re ready, contact a tax professional who can better assist you. They understand that tax rules can be quite complicated and they want to help you. Until you meet with one, here are some helpful tips you can think about as you start your tax planning process.

First, you need to understand your tax bracket. It’s fairly simple in the United States: people who make more will face higher tax rates while those who make less are subjected to lower tax rates. You will fall into one of the seven federal income tax brackets: 10%, 12%, 22%, 32%, 35%, and 37%. While it’s important that you know which one applies to you, just know you probably won’t pay that rate on your entire income as you get to subtract tax deductions to determine your taxable income and the government divides your income into smaller chunks before taxing each one.

Now, you must learn the key differences between tax deductions and tax credits. Both help reduce your tax bill, but a tax deduction can be subtracted from your taxable income while a tax credit gives you a dollar amount that can be withdrawn from your bill.

Do you know the difference between standard deduction and itemizing? You should as the choice you select could have a huge impact in your tax bill. With the standard deduction, it’s a flat-dollar, no-questions-ask tax deduction that makes tax prepping fast than itemizing. The government sets the amount that will be taken from your taxes based on your filing status. Each year, the amount is typically adjusted for inflation. The chart below shows you what to expect as your standard deduction in 2021.

Filing status:2020 tax year:2021 tax year:Single$12,400$12,550Married, filing jointly$24,800$25,100Married, filing separately$12,400$25,100Head of household$18,650$18,880

On the other hand, itemizing your tax return means you want to subtract all your individual tax deductions from your tax return. While itemizing takes longer to complete, the total amount you owe could be significantly lower than the standard deduction.

Since we’re discussing tax deductions and credits, you should also look into popular ones you could use. There are hundreds out there and they all have their own requirements, but spend some time researching which ones you’re allowed to take.

It’s important that you keep your tax returns and documents, just in case you’re ever audited. You should keep them for at least three years as that’s how long the IRS has to decide whether they want to audit your return. You should also keep your tax records for three years if you ever want to file a claim for a credit or refund after filing your original return.

Lastly, here are some great strategies you should know to keep the IRS from confiscating your hard-earned money. These quick tax planning strategies will help you keep more money in your pocket, which can later be used on your growing small business!

• Claim fewer allowance on your W-4, the tax form that tells your employer the amount of tax to withhold from your paycheck.

• See if your employer offers a 401(k) savings and investing plan that will give you a tax break on the money you set aside for retirement.

• There are two types of individual retirement accounts that aren’t employer-sponsored: Roth IRAs and Traditional IRAs. With Roth IRAs, you pay your taxes upfront and the withdrawals you make in retirement are not taxed. On the other hand, Traditional IRAS allow you to make contributions with money you can deduct on your tax return.

• Look into a 529 plan, a savings plan that helps people save money for college.

• Fund your flexible spending account (FSA) as the IRA allows you to funnel tax-free dollars from your paycheck into the account each year.

• Parents with children under 13 years of age should check out Dependent Care Flexible Spending Accounts (DCFSAs). They avoid paying taxes on the cash in the account that can be used for before- and after- school care, day care, preschool, and more.

• Health savings accounts are a tax-exempted option for those paying medical expenses.

References:

Orem, Tina. “Tax Planning for Beginners: 6 Tax Strategies & Concepts to Know.”

NerdWallet, 22 Nov. 2020.