Posted on June 5, 2015 in ,

Financial Planning Basics-Part III

The goal of income tax planning is to minimize your federal and state income tax liability; the less money that you send to the government, the more cash you have in your pocket, hopefully to save for the future and spend.  The income tax code is complicated so it is best to consider deduction planning with your CPA or qualified advisor to review all strategies to lower your  income tax burden.

ORGANIZE YOUR DOCUMENTS

Whether you prepare your own return or pay a professional, preparing your return is largely an exercixe in organizing your documents and understanding the law.  The best time to get organized is now by documenting your income and deductions as you go rather than waiting until next April.

If you own a business or corporation you must maintain separate accounting and tax records, primarily through the use of business checking accounts.  All legal ordinary and necessary business deductions including retirement plan deductions must be coordinated with your professional tax preparer.

UNDERSTAND AFFORDABLE CARE ACT REQUIREMENTS
 
Beginning in 2014, taxpayers must check a box on their return confirming they were covered by an approved health insurance plan.  You don’t have to attach any documentation but you should have proof of insurance in case you are examined.  The rules are very complicated along with the fact that the IRS sent 800,000 Form 1095-A’s which were erroneous.   An amended return for 2014 may be in order.  For answers to ACA tax questions visit the webpage IRS Affordable Care Act.

EVALUATE ITEMIZING VERSUS TAKING THE STANDARD DEDUCTION

Only one in four taxpayers chooses to itemize deductions.  The other three take the standard deduction.  A recent IRS study found that over 2 million taxpayers overpaid their taxes by failing to itemize.  If your itemized deductions are a little short of the standard deduction limit you may be better off by bunching itemized deductions every other year such as real estate taxes and charitable contributions to enable you to itemize.

STATE AND LOCAL TAXES
 
In 2014, Congress extended several popular tax deductions that have been set to expire each year.  One significant one is the deduction for state and local taxes including sales tax paid on purchases.  By totaling your actual purchases subject to sales tax you may be eligible for a much larger deduction than the IRS table amount.

TAX FREE DISTRIBUTIONS FROM YOUR IRA-AGE 70 ½
 
In addition to the extension of the deduction for state and local taxes, Congress extended a break for IRA distributions the past two years.  If you are 70 ½ or older, your Required Minimum Distribution may be paid, with limits, directly to a charity to avoid taxable income.

OTHER EXTENDER TAX BREAKS

Other extender deductions and credits include the $4,000 higher education expenses, school teachers out of pocket expenses, mass transit costs, mortgage insurance premiums and energy efficiency credits.  Check at year end to see if Congress has extended these provisions again for 2015.
 
CHECK YOUR FILING STATUS
 
Most married couples automatically elect “married filing jointly” when they file their tax return.  However, married filing separately may reduce your total income tax liability if you and your spouse have similar levels of income.  Income tax preparation software will compute the tax using the two methods to determine the lowest income tax .
 
INCOME SHIFTING TO FAMILY
 
Shifting income to family members in a lower tax bracket is a tax planning technique often used through a family business.  Partnership interests, sub-chapter S  and LLC earnings as well investment income can be shifted by gifting a portion of the interests to your children.  This methodology should be reviewed by legal counsel and your professional tax preparer.
 
TAX DEFERRAL BY CONTRIBUTING TO A RETIREMENT PLAN

The most efficient way to reduce your income tax libility and build wealth over time is to contribute money to a qualified retirement plan through your employer, such as a 401(k) or SEP plan.  Part of your salary is contributed to the plan which reduces your taxable income.  If you are in a 15% tax bracket a $5,000 contribution only costs you $4,250.  If you are in a 25% tax bracket, the $5,000 only costs you $3,750.   The government is paying you to fund a savings account.   The advantages are tax deductibility, tax deferred growth, forced savings and a creditor proof asset.

MEETING WITH YOUR TAX PROFESSIONAL

Income tax planning is a year round event.  Review pertinent income tax changes and meet with your CPA.  Act now for the April 15, 2016 due date.

Next time:  Financial Planning Basics-Risk Management & Insurance:  Part IV