It’s that time again. Time to project your taxes. Projecting your taxes can not only save you money but it allows you to take control, perhaps lessen your tax liability, and eliminate the stress of surprises on April 15th. One of the best times to start your projecting or planning your taxes is right after you complete your annual tax return. This is when the details of missed opportunities are freshest in your mind and you are the most motivated to do something about lowering your tax bill. Another good time for tax planning is around September or October while you still have time to make changes that can impact your tax bill.
Before you start the process, look over a copy of your last tax return. Be sure you understand the major areas of your return like, where the numbers came from, and what you can do to influence them to lower your tax bill. Make a note of missed opportunities for deductions or credits that you might qualify for this year. For example, if did not have enough medical expenses last year to take a deduction, see if you can group your procedures or expenses to qualify for a deduction next year.
Next, compare your current situation to the previous year. Have you made changes that could affect your taxes, positively or negatively? Some examples include changes to your income, your marital status, and purchasing or refinancing a home. Then create a tax projection for this year that includes any major changes. A projection is nothing more than a mock-up of your tax return. You can ask your tax professional to calculate a projection for you, you can use one of the software packages like Intuit’s TurboTax or H&R Block’s TaxCut, or you can create a template like the one shown here. Once you have a projection of your tax liability, go through each part and look for additional deductions and tax credits you may be eligible for. If you are unsure of what you might qualify for, ask a tax professional.
Beyond deductions and credits you can also influence your tax liability in other ways, here are three common ways:
- Contribute to employer sponsored retirement plans like 401(k)s. Contributing to retirement plans at work reduces your taxable income which means a lower tax bill. If you are not contributing the maximum to these accounts, consider increasing your contributions. For example, if you are in the 25% tax bracket, for every $1,000 you contribute to your 401(k), you will lower your tax bill by $250.
- Contribute pre-tax dollars to your flexible spending account. If your company offers some type of a flexible spending account (FSA), calculate the amount of your annual expenses for things like child care and out-of-pocket medical expenses, and use this account to cover those expenses. Again, if you are in the 25% tax bracket and set aside $1,500 annually in your FSA, you could save $375 in taxes, and have money available for planned expenses.
- Stash extra savings in an IRA. If you qualify for it, a Roth IRA is a great option. Although you won’t save money on your current taxes with a Roth IRA, the future tax savings could be tremendous because you will not owe any taxes on the money while it is growing and, if you follow the rules, your withdrawals will be tax-free.
- Finally, if you are projecting a large refund or a large tax bill, consider adjusting your withholding so you move toward a breakeven point where you don’t get a refund or owe anything. I know a lot of people look forward to a refund each year, but remember a refund is nothing more than a return of your money without interest!
The four strategies listed here are just a few of the most common ways you can reduce your tax bill. But don’t stop there, ask your tax advisor or financial professional for more ways you may be able to save money on your taxes for your specific situation. ps!