Proper Tax Planning Will Help Secure Your Financial Freedom

April 24, 2012 by  Filed under: Taxes 

Tax planning…those two fearsome words that most people embrace with the same amount of affection as going to the dentist. In any case, a savvy individual can keep their financial house in order with just a little bit of organization and tax planning. We all know that we have to pay the taxman, so why not learn a basic amount of knowledge about what it takes to keep the pain to a minimum while ensuring that your financial freedom will not be adversely affected.

I like to think about tax minimization tactics as a stool with three legs where each leg adds a little bit of strength to the stool. When all three legs are developed and maxed out, the “tax” portion of your financial plan has been minimized in your favor. Those three legs consist of 1) reducing your adjusted gross income (A.G.I.), 2) increasing your tax deductions, 3) wise use of tax credits.

To help max out these three legs, you will probably seek the assistance of a professional in this area such as a certified public accountant. While it is certainly possible to take care of your taxes yourself, a prudent individual will seek out a professional so as to bring about as much tax savings as is legally possible. This will surely secure your financial freedom.

  1. Reducing your A.G.I.: There are several techniques you can employ to reduce your adjusted gross income so that the tax that you ultimately have to pay will be computed on a lower gross income number. Two of the more popular methods are 1)contributing to a 401(k) retirement plan and 2) contributing to an I.R.A. Other tactics that are used for adjusting your taxable income in your favor are 3) contributing to an H.S.A. (Health Spending Account), 4) contributing to a 529 savings plan for educational tuition and fees 5) alimony 6) moving expenses. As you can see, the first two of these methods for reducing your taxable income help you now to lighten your tax burden and will help you later when you retire. To see the complete list, take a look at I.R. S. form 1040.
  2. Increasing your tax deductions: Effective tax planning starts on Jan 1st of every year and ends on Dec 31st. This is because if you are diligent about tracking your expenses and donations, you will be certain to not miss any allowable deductions which in turn will soften your tax bite. The largest deductions for most people include 1) home mortgage interest 2) real estate taxes for homeowners and 3) state income taxes. Some other popular deductions include 4) charitable contributions 5) medical expenses 6) casualty and theft losses 7) union and professional fees and 8)tax preparation fees. To see the complete list of deductions, take a look at I.R.S. Form “Schedule A”. If you choose not to itemize your deductions, you can simply pick the standard deduction which increases in your favor if you get married and have lots of children. Ideally, you will compute your tax burden both ways (itemized and standard) and pick the method that garners the best tax treatment for you.
  3. Wise use of tax credits: Tax credits are more valuable than tax deductions because they lower the amount of tax that you have to pay on a dollar for dollar basis where as tax deductions lower your tax due by your marginal tax rate. So for example if you owe $100.00 in taxes and you have $100.00 of tax credits, you owe zero taxes but if you have $100.00 in tax deductions and you are in the 25% tax bracket you would still owe $75.00 in taxes. Tax credits include 1) Earned income credit 2) Hope & lifetime learning credit 3) Adoption credits 4) Child and dependent care credit 5) Retirement savings credit and 6) Credit for the elderly & disabled.

After all is said and done, some people still get a refund from the I.R.S. and feel that this is a windfall or found money! It is in fact your generosity as it represents an interest free loan to our government. You can adjust this refund and keep the money to yourself throughout the year instead of having it withdrawn from your paycheck. You would adjust in your favor (in the case of a refund) or in favor of the I.R.S. (in the case of having to send a check with your tax return) by tweaking your W-4 form at your place of employment.

Chris Borg is a practicing pharmacist and financial adviser who writes about health care and investing. Chris’s latest website on financial freedom is at RatraceBgone, where Chris provides financial tips such as the 9 steps to financial freedom: 9 Steps To Financial Freedom

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