your greatest tax fear is solvable
Tax planning is sitting down, maybe with your accountant, maybe alone, and figuring out how much taxes you are going to owe at the end of the year, and whether you need to do anything to mitigate that tax debt. For my personal taxes, I sat myself down with myself, since I’m an accountant and looked and was like, “Ew, I made more money than I thought I would this year (great problem, you know), and that means I’m going to owe more taxes. Now what am I going to do to make (some of) that not happen?”
First we look at some tax advantages. I will show that in personal finance, and the process is similar though the tax advantages are different for businesses. First, I haven’t dumped a whole lot into my 401(k) yet this year, or into my IRA, so, the first thing is, that 401(k) dollars, even for self-employed people (they get something called a 401(k) solo) are deductible off income, dollar for dollar. Make $100,000, but put $20,000 into your 401(k)? you now have made only $80,000. (you can only contribute 20% of your pre-tax income, and contribution limits are different for employees—max of $19,500) This is where some planning can come in. You can also contribute up to $6,000 to an IRA—and it is deducted from your AGI on your 1040. Now, if you are Married filing Jointly, which I am, and your AGI is less than $65,000, you can take advantage of something called the Retirement Savings Contribution Credit. You can qualify for up to a $2,000 credit if: Total AGI was less than $39,000 and Retirement account contributions exceeded $4,000. There are lesser amounts up to the $65,000 AGI and smaller credits if you didn’t max out this retirement contribution.
If you want to increase the amounts you are contributing, and, like me, your spouse doesn’t work, you can set up a spousal IRA, and dump an additional $6,000 in there. Our person who made $100,000 before taxes is now down to a total AGI of $68,000, just shy of being able to take this credit. Bummer. Is this the end of the tax planning? No, because it’s PLANNING! meaning that we are doing this while we can still do something about it. Maybe, it’s time to look into a larger investment that the customer was wanting to do but hadn’t been ready to commit to. Need to buy that $10,000 piece of equipment and haven’t had the reason to do it? Let’s look at our tax bill if we do.
$100,000 income VS $90,000 income
$20,000 401(k) VS $18,000 401(k)
$12,000 IRA VS $12,000 IRA
$68,000 Net Inc VS $60,000 Net Inc
$4,844 FIT VS $3,484 FIT ($3884 tax minus $400 Retirement credit)
$63,116 Aft Tax VS $56,516 Aft Tax
So, that $10,000 piece of equipment, now that we throw some tax planning in there (and this is just one credit, there are many more that we can work up like this) costs $6,600. Now, yes, I know it costs a bit more because it takes $2,000 out of the 401(k) as well, but it’s still about a 14% savings over the baseline cost. Tax planning may push this one over the edge for this customer. And other tax planning may do more for this customer as well. But this is tax planning and one of the things it does for you.
