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Tax planning is not something that happens only at year end. It seems so many taxpayers are hit with a large tax bill at the end of the income tax year, that they vow to not let that happen next year. However, they either do not know how and where to start, or they just never start any process. You have good intentions, but nothing is put into place. You need tax planning. It is essential for your financial and/or business success. What is it?
A good tax planning program is a year round process. Proper tax planning can help you with the following:
You can help plan for the 2007 tax year by estimating and paying your taxes quarterly. You would use Form 1040ES for this. By paying your taxes on a quarterly basis, you will not have a huge year-end tax bill due. In other words, estimated tax payments can be a very beneficial budgeting tool.
Estimated taxes need to be paid to the IRS when you either 1) do not enough withholding being taken out of your paycheck, or 2) you had over $1,000 of income where taxes were not withheld. The most common sources of income where taxes are not withheld include: self-employment income, alimony, and interest and dividends.
It is usually safe to say that if you had a tax liability in 2006, you may benefit from making estimated income tax payments in 2007. On the average, you can usually estimate your 2007 taxes by using your 2006 tax figures. This applies only if you have not had any wide fluctuations in your financial situation, though.
Be certain that your estimated payment amounts are not too large or too small, however, or the IRS will assess you a penalty.
Do not concern yourself with estimated tax payments for 2007 if during 2006 you had no tax liability or you did not need to file a 2006 income tax return.
A great tool to use to calculate if the correct withholding amount is being deducted from your paycheck is found in the Withholding Calculator. One of these calculators is found on the H&R Block website. There is also one found on the IRS website. The Withholding Calculator can also help you with estimating your taxes.
While it may be too late for most people to lower their 2005 income tax burden, consider it a clean slate for 2006. The beginning of the year is an excellent time for tax planning. There are many steps you can take now to avoid sticker shock during next year's income tax filing season. For example, you can increase your retirement account contributions. You can donate goods or cash to one or more charities. If you aren't already participating in an employer-sponsored dependent care or medical flexible spending account, get some tax advice and planning help from your human resources department or a tax planning professional to determine if they are right for your circumstances. Feeling really bold? Explore the impact enrolling in a high deductible health plan and complimentary health savings account (HSA) could have on your income tax bracket. Before you do any of these things, it's probably best to seek the guidance of an estate tax planning professional to get the most from any measures you do take.
Eligible employees may have as many different retirement vehicles as they choose. Employers can offer a SEP IRA and another type of retirement plan to employees, but doing so requires that the employer either adopt a pre-approved SEP or an individually designed SEP. The employer cannot use Form 5305-SEP. Participating in a SEP IRA has income tax filing consequences for both employers and employees. Both employers and employees should seek tax advice and planning assistance when trying to determine the impact to current and future tax planning scenarios.
Whether you're a teenager working part-time at the local mall or a corporate executive working for a Fortune 500 company, you will receive income tax documents from different sources. Some will document income earned that you need to report on your income tax return. Others will document deductions that you can claim on your income tax return. Regardless of what the form documents, the golden rule is that, with few exceptions, all income tax filing related forms most be postmarked and in the mail to the taxpayer on or before January 31 of the following calendar year. For example, for tax planning purposes, you should plan to receive your 2005 tax documents by early- to mid-February 2006.
If you are trying to get ahead of the curve with your pre-preparation tax planning and organization, keep an eye on your mailbox for important tax documents. You should begin receiving income tax return documents and paperwork in the mail sometime around mid-January. Each situation is a little different, but in general there are common tax documents that most people receive. Employers will send you W-2 forms. If you freelance, clients for whom you've completed at least $600 worth of work should each send you a 1099-MISC form. If you've earned dividends on mutual funds or other investments, you should receive one or more 1099-DIV forms from the account administrator. If you earned interest on your checking or savings account, you should receive a 1099-INT. If you have a mortgage, you will receive a 1098 from your mortgage company itemizing the deductible interest you paid in 2005. You may receive other income tax-related forms as well.
In preparation for Income tax filing, you will need any tax documents you received that state income and deductions, such as mortgage interest or student loan interest. You'll also need to find receipts for deductible expenses such as medical bills and receipts for any charitable donations you made during the year. If you are self-employed, you'll also need to gather receipts for all deductible business expenses. Check out IRS Publication 535 for a complete list of business expenses. Finally, if you have a home office, you'll need to find receipts for the utilities and proof of mortgage or rent payments, among others. You can find a list of allowed home office deductions in IRS Publication 587. Looking ahead to next year at this time, while you're digging up all these records, sort everything and create files to hold your bills; bank, credit card, and retirement account statements; and receipts for deductible items and charitable donations. Then, keep things sorted as they come in during the year. That way, next year's income tax return will be a breeze to prepare.
Tax year 2005 catch-up contribution limits for traditional and Roth IRAs is $500 for a total annual maximum contribution of $4,500. For 401(k), 403(b), salary reduction SEP, and 457 accounts, it is an additional $4,000 for a total annual maximum contribution of $18,000. For SIMPLE plans, the 2005 maximum catch-up contribution is $2,000 for an annual maximum contribution amount of $12,000. Contributing to a retirement account can provide significant income tax advantages. For more tax advice and planning help in determining which retirement account is best for your needs, consult with a qualified tax or financial planning professional.
Catch-up contributions are contributions made to a retirement account by individuals who are or will be 50 years old by the end of a given tax file year. These folks are allowed higher maximum contributions because they are closer to retirement than younger workers.
Medical flexible spending accounts (FSA) function much in the same way dependent care flexible spending accounts do. Assuming your employer offers medical FSAs, you can deposit money on a pre-tax basis into the account. This reduces your taxable income potentially saving you hundreds of dollars in income tax. A medical FSA can be an excellent tax planning tool. Medical FSAs are a little more flexible than dependent care FSAs. If you are slated to deposit $3,000 for the year into a medical FSA, you can make claims against the full $3,000 from day one of the calendar year. Not so with the dependent care FSA in which you can only make claims up to the amount deposited in the account through the claim date. But beware! Both dependent care and medical FSAs are “use it or lose it” accounts. If you don't incur and submit claims for qualified expenses by a certain deadline, you lose your money. For more information on what the IRS considers a qualified medical expense and applicable deadlines, read IRS Publication 502. If you have a lot of medical expenses, you may be better of itemizing on your income tax return if you think your expenses will exceed 7.5% of your adjusted gross income. For tax advice and planning help, consult a financial planner or tax professional.
Deciding whether or not to hire a financial planner can be a huge decision. Obviously, if you win the state lottery you aren't going to stash the winnings under your mattress. But for most people, the need to hire a financial planner is a decision that is arrived at gradually. If you find you need help determining the income tax consequences of certain financial moves you are contemplating, or if you got left holding the bag on a hefty income tax tab, chances are you could use some estate tax planning expertise. Other points at which it may make sense to seek estate tax planning services is when you are preparing a will, getting married, divorced, buying or selling real estate, or planning a family. To help you decide whether you could benefit from the tax advice and planning services a financial planner can lend, visit the public information page of the National Association of Financial and Estate Planning. The site includes links to information about financial planning and a search tool to locate a financial planner in your area.
Health savings accounts (HSA) are relatively new on the tax planning scene. Introduced in late 2004, the intended purpose of a health savings account is to save overburdened consumers money on premiums. For a health savings account to work, you need to have a high deductible health plan (HDHP). HDHPs generally have deductibles of at least $1,000 for individuals and $2,500 for families. In essence, the HDHP really only covers catastrophic care. In exchange for the high deductibles, you get lower premiums. You take the money you are saving on your premiums and deposit it on a pre-tax basis into an HSA. That cuts your income tax bill by lowering your adjusted gross income. Then, you use the money in the HSA to pay upfront for usual medical expenses. Some HSAs offer a debit card that you can use to pay for qualified expenses at the point of service. Others require you to submit receipts for reimbursement. But wait! It gets better. HSAs are not “use it or lose it” accounts like dependent care or medical flexible spending accounts. If you don't use all the money in your HSA, it sits there indefinitely earning interest on a tax-free basis. You can use the money tax-free any time to pay for medical expenses. And if you wait until after age 59, you can take the money out for any purpose and not have to pay taxes on it. So, while HSAs are supposed to be helping the average Joe, skeptics view them as a tax shelter for wealthy Americans. That's because they can be used as an alternative retirement and estate tax planning tool for individuals who have maxed out the limits on their existing retirement plans. Whether you need a tax shelter or a break on health care insurance premiums, the truth is an HSA could save your family big bucks now and in the future on your income tax return. For more information, read IRS publication 969.
If your employer offers a dependent care flexible spending account (FSA), it could save you a considerable amount of income tax. A dependent care FSA allows you to deposit money from your pay into an account that you can then access to pay for qualified expenses for your children up to age 13 or certain adult dependents. The money goes in on a pre-tax basis having the benefit of lowering your taxable income. A dependent care FSA can be a great tax planning tool. You may need to complete paperwork to get reimbursed for expenses you pay out of pocket. More and more accounts are linked to a debit card that you can use to pay expenses directly. Beware though: Dependent care FSAs are “use it or lose it” accounts. That means if you don't use all the money you deposit in the account by the deadline, you lose the money. Also, if you use a dependent care FSA, you can only deduct on your income tax return dependent care expenses above and beyond those that you are reimbursed for through the FSA. For more information on dependent care expenses and FSA deadlines, read IRS Publication 503. If you have questions about whether an FSA is right for you, seek tax advice and planning help from a qualified professional.
Increasing retirement account contributions—whether it's a 401(k) or a 403(b)—is so beneficial on so many levels that it's practically a no-brainer! Aside from saving for retirement itself, something which is a long-range goal that many savers have a hard time visualizing, you're lowering your income tax burden today. That's because contributions are done on a pre-tax basis, which has the immediate effect of lowering your taxable income. Not only does that cut your income tax by a hefty amount, any tax planning expert will tell you it also reduces the amount you pay in Social Security and Medicare taxes. Then there's the employer match to consider. Most employers match employee contributions dollar-for-dollar. If you aren't contributing up to the maximum amount your employer will match, you are throwing free money away. If this isn't enough to convince you to increase your retirement account contributions, get some tax advice and planning help from a qualified professional who can answer your questions.
Once the new year has begun, there are few things you can do to impact your income tax burden for the previous year. However, one thing you can do from a tax planning perspective is open and fund an individual retirement account (IRA) on or before April 15. If you already have an IRA, make an additional deposit up to the allowed limit. Not all IRAs are deductible, so before you open one, you may want to get tax advice and planning guidance from a qualified financial planner. To find a certified financial planner in your area, visit the Certified Financial Planner Board of Standards Web site, and use the search tool.
Any employer can establish a SEP IRA as long as three requirements are met. The easiest way to meet the first requirement of a written SEP agreement is for the employer to complete IRS Form 5305-SEP. Then, each eligible employee—even if it is only yourself—must receive information on the SEP IRA plan, including a copy of IRS Form 5305-SEP. Finally, each eligible employee must open a SEP IRA at a financial institution. The account belongs to the employee, and the employer makes contributions directly to the financial institution that then credits the correct contribution amount to each employee's SEP IRA. Participating in a SEP IRA has income tax filing consequences for both employers and employees. Both employers and employees should seek tax advice and planning assistance when trying to determine the impact to current and future tax planning scenarios.
SEP stands for simplified employee pension. IRA stands for individual retirement account. A SEP IRA is an easy-to-open, easy-to-use IRA that is designed to give employers a way to contribute to their employees retirement savings. A SEP IRA can also be used by people who are self-employed as a means of saving for their own retirement. The IRS has an entire section of its Web site devoted to SEP IRAs called the SEP Resource Library. You can read about how to set up a SEP, who qualifies to open a SEP, contribution limits, income tax deductibility of contributions, and much more. There are also a host of forms and publications in the resource library to help you with income tax filing and tax planning.
Depending upon the level of your tax planning needs, and your skill/knowledge set, you can obtain tax planning information in other ways besides actually sitting down with a tax planning professional. Here are some other ways to be assisted with your tax planning needs:
Online: Many tax firms offer online tax planning advice. Some have an online library offering tax information to help taxpayers plan their taxes. Or, you can obtain insight into how certain events will affect your taxes. This is a self-serve program and is best served by taxpayers with basic tax needs or a fundamental knowledge about how to do tax planning. Tax professionals and taxpayers in general will do well with an online tax planning library. That is, if the information is presented in easy to understand terms and not technical lingo.
Tax Software programs. Many tax software programs include tax planning information. Also, some may include a free advisory contact with a tax planning professional. H&R Block offers this through their TaxCut products – both online and offline.
Library. Go to your local or university library and pursue the periodicals available. Or, read the IRS Code (for those hearty and rather masochistic taxpayers). Not including the IRS code, there are a variety of publications available in easy to understand terms to help you understand tax planning issues.
Books. There are many books available to help with tax planning. Insight into various tax laws as they relate to tax planning issues are discussed. They are written for the general population to understand and contain a wealth of useful information. J.K.Lasser is a very popular one (for instance).
Tax planning seminars. Local tax professionals like to sponsor seminars to inform taxpayers about current issues and tax planning insights. Some charge a fee and some do not. Sometimes these seminars are a way to get new clients for the sponsor. Other times the main purpose is simply to educate.
Personalized – phone, email, chat. Many tax preparation firms offer tax planning services outside of their software program. For the taxpayers' convenience, methods of contact vary from phone to online chat. These forms of contact offer taxpayers a more personalized conversation whereby tax planning issues specific to them can be asked. Check with your tax software program features.
If you decide to meet a tax planning professional face-to-face, there are a variety of professionals for you to choose from. Many are specialized in tax areas such as estates and trusts, real estate, and international business. Others may be specialized in business taxes, small business ownership, and/or individual income taxes. There is bound to be a tax planning professional available that suits your needs. Here is a sampling:
Certified Public Accountants (CPA). After passing an arduous and length professional exam plus going through the required training and application process, one obtains the CPA designation. These individuals have their main bread and butter come from knowing the tax laws. Tax season is their busy time of the year. With that knowledge about preparing income taxes, comes the knowledge about knowing how to prepare, save, and budget for taxes. Plus, CPAs need to keep current with tax laws through continuing professional education. Their fees may be higher than other professionals, however. Check with your state's Board of Accountancy for competence and licensure.
Tax preparation firms. You know tax preparation firms know the tax laws. That is part of the requirement. Some also offer other services to keep them busy during the ‘off season'. This means that they have services available for their clients on a year round basis. However, did you know that one, in particular, offers financial advisory and tax planning services?
Attorneys. Many attorneys offer tax planning services. Otherwise known as a Tax Attorney, they specialize in various areas of tax that involves their clients. For instance, since many attorneys also deal in estates, inheritances, and divorce, taxes come into play. Tax attorneys usually have the JD designation and years of study. Check around to see what is offered in your local area.
Enrolled Agents. Enrolled Agents, trained and certified in the IRS Tax Code, can also help you with your tax planning needs. Many retired Agents open up private practices after retirement from the IRS. Look for them in your phone directory.
Certified Financial Planner. These professionals have obtained the highest level of achievement in the financial planning field by passing an industry exam. They can help you with tax planning in a variety of areas.
During your process of choosing a tax planning professional there are some things you need to do:
The end result of any professional tax planner visit is the ‘Tax Planning Guide'. This will be your financial blueprint throughout the year and for years to come. It takes your financial and tax goals, objectives, and current resources into consideration. One purpose of this Guide is to put you on track to obtain your tax goals and objectives for the future. It also will help you deal with any unforeseen circumstance as it arrives.
Your Tax Planning Guide will not be developed within one hour. It will take hours, if not days, possibly weeks to develop. All the information your tax planner obtained during your initial visit will be consolidated into this one report. Your tax planner will pull together knowledge from all affected areas (such as IRS tax laws and rules) to arrive at the best results for you. These results are realistic for you to meet, also. That is another purpose of a Tax Planning Guide. It will contain short and long term financial and tax planning goals. These will probably be broken down in 3, 5, and 10-year timeframes.
What is important to know about a Tax Planning Guide is the fact that it is not written in stone. As an example, as your life situation changes throughout the years, your Guide will be updated. A life change situation affecting your tax and financial needs would be: divorce, birth, retirement, job loss, business closing, and incapacitation causing unexpected medical expenses – among others. As these events occur, needless to say, they impact your situation both personally and financially. The beginning savings of $50,000 has suddenly dwindled to $1,000 due to those medical expenses. Your situation has changed and you need to reassess.
Your tax planner will go over your Tax Planning Guide with you. Ask any questions you have regarding it. It is important for your tax planner to know that you totally understand your Tax Planning Guide.
As a business owner, it is important to have a business tax plan in place. In addition to easing your year-end tax burden, it can prepare you for a variety of events that will occur throughout your operating year. It also will keep you within your budget in a variety of accounts.
There are a variety of business tax planning moves you can take to make your tax burden more manageable. Here are some suggestions:
Needless to say, it is important to plan for your retirement years. You need to have a retirement “nest egg” that will offer you the chance to pursue your goals, objectives, and dreams. You also need to have a “nest egg” accumulated that will cover you in case of unexpected medical bills, or other worst-case scenarios.
Retirement tax planning consists of, hopefully, a diverse portfolio of investments that will enable you to meet your tax bills and financial goals. It also provides you with choices to better your financial and tax picture. Retirement tax planning is one of the more complex tax planning areas due to its involving a variety of items. For instance, a well-diversified retirement portfolio may contain real estate holdings, stocks, bonds, mutual funds, IRA and/or other retirement plans, plus other investments.
Almost every transaction you do that affects any of your retirement accounts, will involve your income taxes. You need to know how to perform the transaction to obtain the best tax advantage. That is what a good retirement tax planner will help you with.
One of the easiest ways to decrease your retirement assets is by donating a portion of them to a charity you believe in.
Be certain that if you do this, any donated item valued at under $500 is in good condition. That is one of the IRS laws put into effect with the 2006 tax year. Also, be sure to get a dated receipt stating the item given and the fair market value. Donated property could be frequent flier miles, computers, cell phones, office equipment – as examples. Help those in need help others. Everyone will benefit.
There are retirement planning tax tips located on the IRS website. In fact, there is a wealth of information regarding tax laws involving many retirement accounts on this website.
Also, numerous tax software programs contain sections and article about retirement tax planning. And, many tax firms offer online retirement tax planning advice. Or, find a local retirement tax planner. (Many tax planners deal with retirement planning, by the way).
Find the most convenient way for you to get retirement tax planning. It will only be to your benefit.
An estate is the property you left behind when you died. It consists of the assets you accumulated during your lifetime. The purpose of estate tax planning is help with the management, accumulation, and disposition of your assets. It is important to have estate tax planning in place to avoid a whopping estate tax bill upon your death. Gift tax planning involves giving away your property as a gift during your lifetime, in general. Both of these subject areas are very complex and have stringent tax rules and regulations in place.
Estate tax planning generally involves saving and reducing taxes, protecting your assets from creditors, avoiding or reducing probate costs, and making certain your assets are given to who you want them to go to. It also provides for measures that need to be taken if you were incapacitated. Overall, it is to your benefit to have estate tax planning.
Here are some situations that may arise that will cause you to think about if you need estate or gift tax planning:
Do you have a will? As you know, a will is a legal document that spells out who gets what that you own upon your death. If you die with jointly-owned assets, the assets will transfer to your spouse (or whomever you jointly owned them with). However, if you do not have a will, the assets will go to your state. Assets will also go to the state if you own them solely and die.
Even though the estate tax laws have an exclusion of $2 million of assets per individual taxpayer, it is important to protect your assets against any future peril. There is a 46% per tax rate above the $2 million exclusion, also. See why you need estate tax planning? That's a whopper of a tax rate. You need to find ways to lower your estate legally. Good estate tax planning can help you with this.
Gift tax planning consists of asking yourself if you plan on giving any of your property away as a gift. If so, to whom? Your family members, charitable organization, or other? Have you been giving gifts all along? Are they appropriate for your best tax advantage? Do you need a gift tax plan to help you with your gift giving? Are you unsure about how certain gifts will be taxed to you or your recipient? Gift tax planning can help you with these concerns. Also, did you know that the gift you give today could provide you with a larger estate tax exclusion in the future? Your estate tax planner would know this. If done (and planned) properly, gifts can help lower estate taxes.
Estate and gift tax planning are specialized forms of tax planning. They involve complex and every-changing IRS tax laws. Find an estate and gift tax professional who can help you with this complex area.
Every taxpayer at sometime during the year will look for guidance regarding tax issues. For taxpayers who have minimal assets with no severe fluctuations in income or expenses - the answer is probably not. You can probably have your tax planning questions answered by reading a tax library – either online or offline. You may, however, need a tax planner to help you develop a plan to obtain your investment goals and minimize their tax impact.
However, for other taxpayers having more complex tax issues – the answer is probably yes. If your spouse died, you got divorced, or have purchased a large dollar item – you will benefit from a tax planner. This is but a sampling of life situations that may arise pointing you towards the need for a tax planner.
If the dollar value of your tax concern is large enough, you may need a tax planner. Usually if an item has a large dollar value figure attached to it, there are tax issues to be concerned about. You need to know how to handle the transaction properly to get the best tax advantage for it. This is especially true if you read the IRS tax laws and do not understand how they apply to you.
If you own property, should it be in your name? Or, can you receive tax benefits otherwise? Your tax planner would be able to help you with this.
If you have an estate of significant size, you will definitely need a tax planner. Even an estate that is smaller in size will need tax advice. You need to protect your assets. However, you tax planner will specialize in estate tax planning. They can help you in this area.
If you own mutual funds, stocks, and bonds, you can benefit from a tax planner. They definitely will show you how to minimize your transactions affecting these investments.
Business owners can benefit from a tax planner. Tax planner could help with year-end tax strategies, retirement plans, expenses, and deferred income tax options – to name a few areas you can benefit from their help.
If you have rental property, your tax planner can help you put it to your advantage tax-wise. They know about timing issues, rental IRS laws, etc.
A tax planner will work with you in developing a personalized tax planning strategy that will guide you along your tax and financial success. Having them as part of your team can help ease your mind.
It's the end of February and you still haven't received all the Income Tax Filing documents you were expecting? If you're expecting a refund, that can be a real pain. However, there's technically no need to worry. First, try calling the employer, investment company, bank, or lender. If they say they've already sent the document(s), ask that a replacement be sent immediately. If that doesn't get results, you will need to call the IRS for help at 1-800-829-1040. Remember, even if you don't receive a form that you were expecting, the IRS may have. It is your responsibility to make sure you report all income from all sources on your income tax form.
If your employer does not have a copy or refuses to provide a Form W-2 for Income Tax Filing, contact the IRS to report the problem: (800) 829-1040. With the information you provide, the IRS will prepare a Form 4852 - Substitute for Form W-2, Wage and Tax Statement - that you can use for income tax filing purposes.
|Jennifer Mathes, Ph.D.|