Whether you are a businessman or an employed professional, tax planning plays a crucial role in managing finances. Tax planning is a process through which one can analyze their financial plans and ensure tax efficiency. Tax law firm Virginia Beach recommends individuals consider tax planning as it allows one to maximize tax breaks and reduce tax liabilities.
Tax laws and rules keep changing with time. This makes tax planning a complicated task. Any mistake in preparing tax planning can lend you to the bad books of the IRS. In this blog, we have discussed a few strategies to use for planning your finances and taxes.
Strategy 1: Understand the Tax Bracket
Tax planning starts with understanding your present financial standing. The first tip to get a good grip on your tax plans is understanding what tax bracket you fall under.
In the U.S, we have a progressive tax system. People earning higher taxable income have to pay higher tax returns. Similarly, people earning lower income have to pay low tax returns.
There are a total of seven income tax brackets. They are 10%, 12%, 22%, 24%, 32%, 35% and 37%.
An individual falling on any tax bracket doesn’t pay that tax rate on their real taxable income. Here is why.
- When calculating taxable income, one should subtract tax deductions from their entire income.
- The taxable income is not multiplied by the tax bracket one falls in to determine the total tax return. According to the rule, the government divides the total taxable income into parts and then taxes each part individually.
Strategy 2. Knowing the difference between tax deductions and tax credits
When preparing the tax return, tax credits and tax deductions reduce the tax bill. However, the two are entirely different terms and work differently. Understanding how tax credits and tax deductions affect your tax return can help you prepare a robust tax plan.
Tax deductions are expenses that can be subtracted from your entire income. The remaining amount is then subjected to taxes.
On the other hand, tax credits reduce the tax bill at a dollar-for-dollar rate. For instance, if you have a tax credit of $2,000, you will have to pay $2,000 less on your tax return.
Strategy 3. Understand the standard deduction vs. itemizing
In tax planning, one must choose between itemizing and standard deduction. Whatever you choose will have a considerable impact on your tax bill.
Let’s understand what each of these terms means.
- Standard Deduction
A standard tax deduction allows one to escalate their tax preparation process at a much faster rate. The standard deduction amount is set by Congress and readjusted every year. Your tax filing status will determine what standard deduction you are qualified for.
- Itemized Deduction
In itemize, one can itemize their tax deductions one by one and pay the taxes. Itemizing allows one to get more tax deductions compared to the standard deduction. However, the process can be lengthy and tedious. IRS Lawyer Virginia Beach suggests taxpayers use IRS Schedule A to claim their itemized tax deductions.