Should you be thinking about taxes when it isn't even April yet? If you don't want to pay the IRS more than you have to, absolutely. Start planning now to maximize your deductions and minimize your tax bill.
Check Your Withholding
Did you know taxes aren't really due on April 15? If you don't have your employer withhold enough taxes throughout the year, you could end up paying extra fees and interest. If you have too much withholding, you take money out of your budget to give the IRS an interest-free loan.
Consider adjusting your withholding if any of the following apply:
- You had to write a big check or got a large refund when you filed last year.
- You had a baby.
- An adult child is no longer considered a dependent.
- Your eligibility for special credits or deductions, such as mortgage interest or education, has changed.
- You or your spouse changed jobs or started a side business.
Reevaluate Your Retirement Plan
Retirement plans are complicated, so many people end up filling out the initial paperwork and forgetting them. Remember that different plans have different tax consequences, and saving money on your taxes is just as good as earning investment returns.
The main thing to look for is whether your retirement plan is pre-tax or post-tax. Pre-tax plans, such as traditional IRAs or 401(k)s, give you a tax deduction in the current year, but you pay taxes when you withdraw funds. Post-tax plans, such as Roth IRAs or Roth 401(k)s don't give you a deduction now, but withdrawals are tax-free.
There are four main questions to ask when deciding what to do:
- Do you think your tax rate when you retire will be higher or lower than today?
- Is there a strong likelihood you might need to withdraw the money early for an emergency or a major purchase, such as a home down payment? Pre-tax plans typically have higher early withdrawal penalties.
- Are you eligible for special tax credits, such as the Saver's Credit?
- Can you get free money from employer matching?
Look for Available Tax Credits
The IRS list of tax credits and deductions is always changing and so are eligibility requirements such as minimum or maximum incomes or the amount of spending that qualifies for a credit or deduction.
There are two ways to take advantage of these credits. One is just to get a nice surprise that you qualified for a credit when you file your taxes, but that could leave money on the table.
Credits are often available for things such as energy-efficient appliances, electric cars and education spending. If you're considering a major purchase or life decision, check for possible credits early.
If a credit is expiring or new, you might need to act before the end of the year or wait until next year. If it's for something such as an appliance purchase, spending a little extra to buy a qualifying appliance could give you even more savings on your tax bill.
One Myth to Avoid: Staying in a Lower Bracket
Many people worry that increasing their income might increase their tax bill by more than their new earnings. However, increasing your income will almost always increase how much goes into your pocket.
The reason is that tax brackets operate on a sliding scale. For example, an income of more than $90,750 but less than $189,301 puts you in the 28 percent tax bracket, but that doesn't mean you'll pay 28 percent on all your income. The 28 percent rate only applies to dollar number 90,751 and higher. Each dollar below that is still taxed at the 25 percent rate or lower.