Year-end tax planning is a practice aimed at avoiding tax penalties and making the most of the tax deductions and credits you may be eligible for. You can take these steps at any time throughout the year, but taxpayers can take some last-minute actions to turn their tax situation in their favor.
Using Online Tax Preparation Software
According to the Internal Revenue Service (IRS), 90% of all personal tax returns were filed electronically in 2021, the most recent year for which comprehensive statistics are available. Online tax preparation software has become the most common way for individuals to file tax returns.
One of the most significant advantages of using online software is that it is straightforward and accessible. The process will be much easier if you gather the information you need before calculating taxes and preparing the return. You should collect some information before starting the process:
- Last year’s tax return: Use it as a template to estimate what should be included in the current year’s return.
- Pay stubs: These will show your income to date and retirement plan contributions.
- Investment statements: These will show the realized and unrealized gains and losses in any trading or investment accounts you have.
- Miscellaneous information about expected income and deductions: This may include anything related to healthcare expenses, mortgage interest, estimated net income from self-employment, and information about any other tax transactions you made throughout the year.
Advantages:
- The software will be updated with the latest regulations and tax changes.
- You will get accurate solutions as long as you enter the correct information.
- The software can guide you to discover credits or deductions you may not know about.
Disadvantages:
- It may be difficult to gather all your tax documents and information.
- You may need to use external sources to calculate more complex situations, such as taxes on Social Security benefits.
An online tax calculator can be a useful tool to help you get a rough estimate of your federal tax liability for the current year. It will assist you in estimating deductions, exemptions, and tax credits. But again, you need to have your information on hand so you can enter it into the appropriate fields on the tax calculator.
Using Last Year’s Tax Return
A simple way to conduct year-end tax planning is to print last year’s tax return and write your estimates for this year’s figures in the margins. You can make a rough estimate by comparing this year’s numbers with last year’s figures. You can control how detailed you want to be by adding more information or removing it from each item. You can simplify the process by updating only those items that differ significantly from the previous year if you only need a rough estimate of your tax situation.
Advantages:
- It is a quick process.
- It takes minimal effort to reach an estimate using this strategy.
Disadvantages:
- You may not be aware of changes in tax law that could affect your calculations.
- You need to have last year’s tax information readily available.
Look for any last-minute ways to take advantage of available deductions to reduce your tax liability if it seems like you may have reached a higher tax bracket or have a larger tax liability than last year. Additionally, you might consider realizing capital gains or increasing your income if you have room in your tax bracket to generate more income.
Note: Your tax rate is determined by your income bracket. This number alone will affect all other calculations on your return. Bracket thresholds change annually, so check the IRS website for the latest figures.
Hiring a Professional
You can
Hire a certified accountant or qualified financial advisor to conduct year-end tax estimation for you. This is the most expensive option, but it is also one of the simplest ways to achieve the best results. You are likely to receive the most accurate information, along with logical recommendations about which options are available to improve your tax situation.
Advantages:
- The professional will know which questions to ask you to gather the necessary information.
- They will provide specific advice for your individual situation and can assist you in dealing with complex issues.
- You won’t have to do any calculations yourself.
Disadvantages:
- This is the most expensive option.
- Most professionals charge hourly rates, so the longer you spend getting the correct results, the higher the cost.
You will need to provide the advisor with an estimate of everything you think will affect your tax situation if you choose this option. Then ask for advice on what types of retirement plans you might want to contribute to, ways to increase your deductions, or whether you should realize capital gains or losses intentionally.
Frequently Asked Questions (FAQs)
How do capital gains and losses affect income?
If you sell an asset for more than its adjusted basis, which is the amount you paid plus any costs incurred to maintain and sell it, you realize capital gains. If you sell the asset for less than its adjusted basis, you incur a capital loss. Gains are added to your taxable income, while losses are subtracted from it. Short-term gains and losses come from assets you’ve held for one year or less and are taxed at your ordinary tax rate along with your other income.
What is marginal tax rate or tax bracket?
The marginal tax rate is the rate that applies to your highest dollar of income and any additional income you earn, up to the next tax bracket. The next highest tax bracket becomes your marginal tax rate or marginal tax bracket. You do not pay this rate on all your income, but only on the portion that falls within that bracket. This differs from your effective tax rate, which is the percentage of your total income that you pay in taxes.
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Sources:
- Internal Revenue Service (IRS). “Returns Filed, Tax Collection and Refunds Issued.”
- Internal Revenue Service (IRS). “Topic No. 409: Capital Gains and Losses.”
- The Budget and Policy Priorities Center. “Policy Principles: Marginal and Average Tax Rates.”
Source: https://www.thebalancemoney.com/year-end-tax-planning-2388991
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