If you have reached a point where your income and investments leave you feeling like you need to be better prepared at tax time, you might have decided that it's time to consider some tax planning steps. For those who have never even thought about tax planning in the past, that can feel a little bit intimidating. Don't let it leave you feeling unprepared. Here are a few of the things that you should consider when you first start tax planning.
Know Your Bracket First
Before you can establish an adequate tax plan, you need to understand what your tax liability actually looks like. That means evaluating your annual income and identifying your tax bracket. Remember that the tax system is tiered, so you'll pay different percentages in tax for different levels of income. For example, your first $10,000 may be taxed at a different rate than the next $12,000, and so on. Knowing your tax bracket can help you roughly estimate your base tax liability before any credits or deductions are considered.
Consider Itemizing
You can choose between itemizing your deductions or just taking the standard deduction each year. For many people, taking the standard deduction is sufficient, and itemizing wouldn't net any more significant deduction for the added effort it requires. However, some people do find that itemizing their expenses, provided they are supported by receipts and documentation, can result in a more significant deduction that may save you more in the long run.
Explore Deductions And Credits — And Know The Difference
One of the biggest mistakes that people make when they start tax planning is failing to understand the difference between deductions and credits, or not thoroughly researching the ones that are available. Make sure you take the time to go through the credits and deductions that are available or talk with a CPA who can help you find the right options for you.
In addition, understand how deductions and credits are applied differently. Deductions reduce your taxable income. This can reduce your tax liability, but not by nearly as much as credits do. Credits are deducted directly from your actual tax liability, not your income. That means that, instead of saving a percentage the way that you do with deductions, you save the full amount with credits. Prioritize tax credits where you can find them to make a big difference in your final tax bill.
These are some of the things you should know when you're early in your first tax planning stages. Consult with a tax preparation service for more advice.
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