Maximizing deductions and credits is an important part of tax planning. Deductions reduce taxable income, while credits reduce the amount of taxes you owe dollar for dollar.
Strategies to minimize your tax liability include correctly claiming deductions, taking advantage of credits, and keeping good records. You can also use tactics such as bundling expenses and timing investments to lower your tax bill.
1. Review Your Financial Situation Prior to Year-End
Many people pay more tax than they are legally obligated to because they don’t take advantage of eligible deductions. Deductions are specific expenses you can subtract from your taxable income while tax credits lower your tax bill dollar-for-dollar.
Reviewing your situation before year-end can help you identify opportunities to reduce your liability. For example, if you expect to be in a higher tax bracket next year, it might make sense to defer income into this year by postponing bonuses, self-employment billings and investment earnings. You can also accelerate deductions such as deductible expenses and contributions to tax-deferred savings accounts or charities.
It’s also a good idea to consider whether you should itemize your deductions instead of taking the standard deduction. Talking to your financial professional early in the year can help you determine which option will save you the most money each year. This is especially true if you have a family member that may qualify for the medical expense credit or child and dependent care credits.
2. Keep an Itemized List of Expenses
Itemized deductions can include unreimbursed medical expenses, real estate taxes, charitable donations, and more. However, there are some limitations that may reduce how much you can deduct. For example, the IRS limits how much you can write off for medical expenses and it only allows donors to deduct a certain percentage of their adjusted gross income.
In general, itemizing only makes sense if your total itemized deductions are greater than the standard deduction for your filing status. If you aren’t sure whether you should itemize or take the standard deduction, a tax-preparation professional can run the numbers both ways and let you know which method will save you more money.
If you’re on the itemize-or-not borderline, consider “bunching” your deductible expenses in one year. This means cramming in as many of the following categories as possible, in order to surpass the standard deduction:
3. Take Advantage of the Standard Deduction
Most taxpayers take the standard deduction, which is a fixed amount that lowers your taxable income. In general, it only makes sense to itemize deductions if their total value is more than the standard amount.
For tax year 2022, the standard deduction is $25,900 for single filers and $34,600 for married couples filing jointly. If you’re unsure whether itemizing makes more sense, you can use the tax bracket calculator.
Often, people miss deductions because they don’t keep track of their expenses throughout the year. This is especially true if they’re worried about the IRS auditing them.
You can prevent this from happening by keeping good records. This includes receipts, sales slips, invoices, and proof of payment such as canceled checks and credit card receipts. This ensures that you can accurately report your deductible expenses come tax time. It also helps you avoid missing any potential deductions. This is a crucial aspect of tax planning and something that’s easy to overlook.
4. Keep Good Records
A tax deduction reduces your taxable income, which in turn lowers the amount of taxes you will owe. Tax credits, on the other hand, directly reduce your tax liability on a dollar-for-dollar basis.
Typically, taxpayers choose to take the standard deduction or itemize their deductions when filing their tax returns. The key to maximizing your deductions is careful planning, especially if you intend to itemize. Itemized deductions include medical expenses, interest on mortgages and other debts, gambling losses, state and local property taxes, charity donations and theft and casualty losses from federally declared disasters.
The best way to maximize your deductions is to work proactively with a tax preparation specialist throughout the year. This not only helps you manage your taxable income but can also prevent costly mistakes that may result in a lower refund than you deserve come tax time. For more tips and strategies for lowering your tax liability, contact a Bench accountant.