Learning Income Tax Basics
Very few people like to think about income taxes. It’s little wonder why — they represent a significant, often resented expense for most taxpayers. But that lack of consideration often leads to a lack of understanding, even when it comes to the most basic aspects of income tax. This is unfortunate, because once you start to understand it better, you see that you have more control over how much you pay in taxes each year than you realize.
Much of your control depends on the type of strategy you use. For instance, contributing to your company’s 401(k) plan or an IRA will reduce your current year income taxes. Familiarizing yourself with federal and local deductions and credits, then planning accordingly, can save you thousands come tax season. If you discuss your tax situation with a professional, he/she can help you find any areas in which you are missing out on potential savings. This is especially recommended when the tax code has undergone recent and significant changes, such as the new tax bill enacted last year.
Sometimes your tax strategy can boil down to smart timing. When it comes to major financial transactions, like selling a home or investment, your tax bill is largely affected by the circumstance. For instance, if you purchased a home and lived in it for less than two of the last five years, you will have to pay capital gains tax on your profits from the sale. There are exceptions, mostly for members of the armed forces who may be deployed or assigned elsewhere, but for most people, this tax can be avoided if you stay in the house for a full two years. Knowing this beforehand and planning out life changes in advance (as much as possible) can help you plan out and time these transactions wisely.
Companies keep meticulous records for tax purposes, devoting filing cabinet after filing cabinet to the storage and organization of receipts and documents that support anything they wish to claim to put the company in a better situation. If only every individual person did this as well. Maintaining good tax records, even if you’re unsure of how helpful it will be when you’re filing your taxes, is not only essential when it comes to backing up your claims, but also reminds you of what resources you’ve expended over the past year. Not everything is deductible, but the more records you keep, the better prepared you are to claim and support deductions and thus lower the amount of tax you owe.
While preparing for your taxes by having a sound strategy and smart timing is a great way to save money and make wiser choices, it is important to remember that the decisions you make in life should not be made solely for tax reasons. Of course, you want to minimize the amount you have to pay in income taxes, but any transaction has to be ultimately beneficial for you and your family. For instance, if you’ve lived in your house for fewer than two years, but you or your spouse receives a job offer out of state, you will have to decide if keeping your family together (and not balancing two mortgages) is a better option than just paying the capital gains tax rates on the profit of your house sale. Just because one situation is better for your tax bill doesn’t mean it is better for you — but understanding the true tax ramifications of your transactions will help you make more informed decisions for your circumstances.
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This newsletter was prepared by Integrated Concepts Group, Inc. The opinions expressed in this newsletter are for general information only and are not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. The views expressed are those of the author and may not necessarily reflect those held by PlanMember Securities Corporation. Material presented is believed to be from a reliable sources and PSEC makes no representation as to it accuracy or completeness.