Everybody wants to pay as little in taxes as possible. Most people use software to help them find all the deductions they can subtract from their taxable income and all the credits they can subtract from their final bill. But most tax breaks require you, the taxpayer, to plan ahead.
Here are some tips from the IRS about year-round tax planning:
- Taxable income is what’s left over after all your eligible deductions are subtracted from your adjusted gross income. This includes the standard deduction. Although most individual taxpayers take the standard deduction, some taxpayers choose to itemize their deductions because it lowers their taxable income.
- As a general rule, if a taxpayer’s itemized deductions are larger than their standard deduction, they should itemize. In some cases, taxpayers may even be required to itemize.
- Taxpayers can use the Interactive Tax Assistant to see what expenses they may be able to itemize. Or they can discuss their situation with a qualified tax professional.
- Taxpayers can subtract tax credits from the total amount of tax they owe. To claim a credit, taxpayers should keep records that show their eligibility for it.
- The American Rescue Plan made changes to several valuable tax credits, including the child and dependent tax credit, the childless earned income tax credit and the child tax credit. It’s important for taxpayers to understand how these changes may affect their 2021 tax return.
- Properly claiming tax credits can reduce taxes owed and boost refunds. Taxpayers can check now to see whether they qualify to claim a credit next year on their tax return. Some tax credits, like the EITC, are even refundable, which means a taxpayer can get money refunded to them even if they don’t owe any taxes.
Child Tax Credit
Important changes to the child tax credit will help many families get advance payments for the credit starting this summer. The IRS will pay half the total credit amount in monthly payments beginning July 15. You will claim the other half when you file your 2021 income tax return. These changes apply to taxes for the year 2021 only.
To qualify for advance child tax credit payments, you — and your spouse, if you filed a joint return — must have:
- Filed a 2019 or 2020 tax return and claimed the child tax credit on the return; or
- Provided the IRS with your information in 2020 to receive the economic impact payment using the Non-Filers: Enter Payment Info Here tool; and
- Resided in your main home in the United States (the 50 states and the District of Columbia) for more than half the year or have filed a joint return with a spouse who has a main home in the United States for more than half the year; and
- A qualifying child under age 18 at the end of 2021 who has a valid Social Security number; and
- Made less than certain income limits.
Although the Tax Cuts and Jobs Act of 2017 (TCJA) eliminated many deductions outright, there are exceptions. Certain deductions still exist but are being phased out, whereas others will expire after a set time. This means good tax planning remains an important aspect of good financial health.
Following are six steps you can take right now to prepare for your future taxes:
1. Adjust withholdings. Determine whether you are someone who takes out more taxes every pay period so that you get a tax return, or whether you want the benefit of having the cash on hand right now. Adjust your withholding accordingly by filing a new Form W-4.
2. Organize receipts. Start organizing your receipts now so you don’t accidentally miss a deductible expense or a tax credit. Check the standard deduction for your situation, and consider whether you might need to itemize.
Having your receipts ready eases the tax preparation process. You should have the following categories of receipts and other documents handy:
- Last year’s federal, state and local tax returns
- Receipts/statements/cancelled checks for medical and drug costs, health savings account contributions, charitable contributions, contributions to retirement plans
- Business travel and meal expenses (including a mileage log)
- Childcare expenses
- Receipts related to your home, including mortgage and line-of-credit expenses, repair and renovation expenses, real estate and school taxes (not all of these will be deductible, but they may help reduce your basis when you sell your home)
- Any receipts related to a home purchase or sale
- Receipts related to life events like marriages, divorces, births and deaths
3. Review your investment strategy. Short-term investments (those held 12 months or less) don’t get special treatment, but long-term investments (those held longer than one year) are typically taxed less.
4. Review your charitable contribution strategy. If you make large contributions, it may make sense to alternate the years in which you make the contribution so you can exceed the threshold for the standard deduction.
5. Evaluate tax credits. Consider whether you’re eligible for any tax credits so you can take full advantage of them. Tax credits are important because they are dollar-for-dollar reductions in the amount of taxes you owe. These credits may be refundable or non-refundable. Refundable tax credits can reduce your tax liability below zero, while a nonrefundable credit cannot.
6. Review your estate plan. No one knows what is going to happen in the future. TCJA changed many deductions related to gifts and estates; take this time to review the changes and make sure your estate plan reflects your wishes and is current. Keep in mind that some of the provisions now in effect are due to sunset in 2025.
You can learn more about tax deductions for individuals on the IRS website.
If you have more questions about how to make sure you’re getting all the money you’re owed, contact us.