Tax Planning & Filing Your Taxes

Table of Contents
Chapter 1: Manage Your Taxes
Chapter 2: Estimated Tax Payments
Chapter 3: Capital Gains Tax
Chapter 4: Tax Planning & Filing Your Taxes
Chapter 5: Lowering Your Tax Liability
Chapter 6: Tips for the First Time Tax Payer

Tax planning, which is an important component of your financial plan, includes many aspects of your income, expenditure, investments, retirement plans, filing status and other financial elements that enable you to minimize your tax liability. Tax planning helps you understand the various forms, clauses and rules involved in filing tax returns and also helps in reducing your taxes.

To file your tax, you need to have proper knowledge of the tax brackets, the forms you need to fill, and the deadlines you need to meet. Here is a brief note on all these aspects.

Form W-2

The most important aspect when planning or filing your tax is form W-2, which is a wage and tax statement provided by your employer. The total wages for the year from your W-2 has to be mentioned in the Form 1040EZ, 1040 or 1040A. If you don’t receive it automatically, ask your employer for it. If the employer refuses to issue the form, you need to contact the IRS.

Reporting Your Taxable Income

When you file your taxes, you have to report your taxable income accurately. To report your income to the IRS, you need to understand the different sources of your income that are considered for tax purposes and the liabilities and expenses that can be excluded from it. Your taxable income is the net income after all your pre-tax deductions for 401k and other tax deductions you are eligible for.

Tax Bracket

It is important to know the tax bracket for your income as different portions of your income fall under different tax categories. Your tax bracket is defined by your income and your filing status. These factors decide the tax percentage you are going to pay.

Types of Income Considered for Tax

Here is a list of various sources of income that are considered for tax calculation.

  • Salary – If you are employed, the first component of your taxable income will be your salary.
  • Dividends – The dividends from your stocks and mutual funds are considered a part of your income for tax calculations. Most of your dividends are ordinary dividends, but some dividends that qualify for reduced tax rates are known as qualified dividends.
  • Alimony – Alimony is taxable income if you are receiving it and is deductible from your income if you are paying it.
  • Business Income – Income originating form your business, freelance work, independent contractual work, manufacturing and selling merchandise or from other professional services is considered taxable business income.
  • Capital Gains – Income from the profits earned by purchasing and selling your assets like stocks, real-estate, collectibles etc attracts a capital gains tax.
  • IRA distributions – The income you withdraw from various pension plans like IRA, 401k etc attracts tax, though it is excluded from tax before you withdraw it.
  • Pass Through Income – Income from rentals, royalties etc have to be reported under schedule E.

Income as a part of your social security benefits may or may not be taxed based on your income from the other sources.

Choosing the Right Tax Form

Once you have figured out which of your incomes are taxable, you need to choose the right form to file your tax. Here is a short note on various forms that are used for filing taxes.

  • If your income is under $100,000, you have no adjustments, you are married or single under 65 years of age and you are claiming only the standard deductions without any credits, you can use the shortest and the easiest form 1040EZ.
  • Most tax payers are required to use the Form 1040A or the ‘short form’ that allows you to claim the most common income adjustments and a few tax credits.
  • The long form or the Form 1040 can be used by all taxpayers. You must use it if you have an income more than $100,000 including income from rents, business, foreign earnings, capital gains and have various income adjustments, tax deduction and credits.
  • In addition to any of the above forms, you must also use form 1099-R to report distributions from various retirement plans.

Filing Status

You can only have one filing status in your tax form – single, married filing jointly or separately, widow/widower with dependant child or head of household. Your filing status decides the tax rates and the tax deductions that apply to you.

Important Dates and Deadlines

It is important to keep a track of all the key dates and deadlines for filing your tax and paying your estimated taxes to avoid penalties and late charges. Check the IRS websites for specific dates for the filing year.

Penalties and Interest Charges

To avoid penalties, you need to pay at least 90% of the tax you owe the IRS for that particular year or 100% of previous year’s tax amount, whichever is smaller when paying estimated tax. Failing this, the IRS charges penalties for underpayment and late payment of tax. Apart from that you could also be charged interest on unpaid tax, late payment penalty, and late filing penalty.

Next: Lowering Your Tax Liability