Tax Planning 101: The Beginner’s Guide for Individuals

In the United States, the amount of taxes you pay is based on your gross taxable income. Tax brackets are set up to correspond to the amount of tax each dollar of income is subject to within that tax bracket.

By understanding your tax bracket, you can plan out taxes with the goal of reducing the amount of income subjected to the highest tax bracket. You can even use deductions and other savvy tax accounting to lower yourself into an entirely different tax bracket.

Here’s a look at the 2022 tax bracket set by the Internal Revenue Service:

To maximize these tax benefits, you’ll want to follow the “5 Pillars of Tax Planning.” These pillars are as follows:

Deducting

Have you claimed all popular deductions available to you? Although most consumers are best served by taking the standard deduction offered by the IRS, some taxpayers can reduce their tax obligations by itemizing these deductions.

Common deductions can include the following:

• Medical expenses
• Tuition costs
• Charitable giving
• Mortgage insurance
• Property taxes
• Contributions to HSAs, Dependent Care FSAs, and other tax-free funds

Deferring

Deferring taxes can be a great way to incentivize investing and to delay payment of taxes until a time in the future when you’re more likely to pay a lower tax rate. This strategy is common for contributions to 401(k)s and other retirement accounts (other than Roth accounts, which are not tax-deferred), and it can reduce your present-day taxation by putting away money to fund your retirement.

Related: Tax Planning: When Are Taxes Due

Dividing

In cases in which family members are filing taxes separately, the process of dividing income can distribute income to taxpayers who will be taxed at a lower rate, resulting in overall tax reductions for the family as a whole.

Disguising

Certain types of income can be accounted for in different ways to reduce your overall tax burden. For example, capital gains from a taxable investment can be deposited into a tax-deferred retirement account, thereby reducing your overall taxable income. Because taxable gains are often taxed at a lower rate than earned income, you can use this transaction to move income out of your highest tax brackets.

Dodging

The name of this pillar may sound sketchy, but the process of dodging is really as simple as moving money from taxable to non-taxable accounts. You might do this through retirement account rollovers, property investments, or other strategies that shelter your money from taxation.

In addition to these five pillars, keep an eye out for applicable tax credits that can cut down on your taxes owed. Tax credits may be issued for education costs, electric vehicle purchases, or a wide range of other government initiatives. 

These credits can change from year to year, so do your research to see which ones may benefit you in the current tax year. A single tax credit can cut hundreds or even thousands off of your tax bill, which can make a big difference to your checking account.

In most cases, the IRS has three years to decide whether or not to audit your return. For this reason, it is recommended that taxpayers hold on to all of their tax return documentation for at least three years.

Some of this information, including copies of past years’ tax returns, may also be requested by mortgage services or other lenders as they review your income history. Keep these documents in a safe place, and consider using an accounting tool such as QuickBooks, which can help you store and manage receipts for deductible personal and business expenses.

By keeping these documents in a safe place, you’ll save yourself a lot of stress when you need that information to facilitate an audit or a loan approval.

By maximizing their deductions, claiming credits, and moving around money to minimize their tax obligations, the average taxpayer can save hundreds or even thousands on their annual tax return, reducing that looming Tax Day payment—or increasing the size of their tax return.

If you’ve never given taxes much thought or you assume you don’t earn enough for savvy tax practices to save you some money, it’s time to think twice and take a second look at your tax filing practices. Whether you want to file your own taxes or hand that process off to a professional, make sure you’re keeping receipts, tracking deductions, and maximizing every opportunity to keep extra money in your pocket.

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