Every person wants to minimize their tax liability. Individuals frequently make the same mistakes again and again. Knowing the common tax planning mistakes and how to avoid them is essential.
Alternative Minimum Tax
Many people ignore the alternative minimum tax, which costs them money. They need help with tax planning because this tax is an entirely separate income tax system. The rules are different as well. Individuals subject to the alternative minimum tax must figure their tax bill two ways and pay whichever amount is higher. They won’t be eligible for deductions such as property taxes and state and local income taxes either. Fortunately, this tax only applies to high-income earners.
Tax Deductions
Countless individuals ignore charitable contributions when they are entitled to deduct them from their taxes. They need to use valuation software to determine how much these items are valued so they can mark off the total amount. In addition, when a person has out-of-pocket expenses while working for a charity, they may deduct them from their taxes. Home office deductions are other write-offs that are often ignored and shouldn’t be.
Mutual Fund Dividend Reinvestments
Individuals who reinvest their dividends are buying extra shares in the mutual fund. The cost of these shares should be added to the tax basis when calculating the taxable gain from a sale. If a person fails to do so, they will pay the IRS more than they need to. When the fund tracks the average sales basis for investors, it automatically includes these dividends in the calculation. If the fund does not do so, it falls on the investor to ensure they take these deductions.
Carryover Items
Many people fail to include carryover items on their taxes. If capital losses in a prior year exceed the annual deduction limit, unused losses may be carried over to the following year. The same holds for charitable contributions that exceed the limit. Individuals need to ensure they take all deductions to minimize their tax liability.
Retirement Plan Beneficiaries
Retirement account owners need to name a beneficiary for each policy. Most people name their spouse. Those who don’t, however, find the money goes to their estate. Heirs must empty this account within five years rather than over their lifetimes. They pay more in taxes as a result. Individuals who name their grandchildren as beneficiaries must take care if the funds in this account are significant. The grandchildren may pay a generation-skipping transfer tax.
Estimated Tax Payments
Men and women must pay estimated taxes quarterly if their employer does not withdraw funds for this purpose. Some people forget, and others wait for no reason. The IRS charge is an estimated tax underpayment penalty of approximately 8% per year for every quarter the individual does not prepay these taxes. Individuals should wait to pay this tax after a big income event. They should let the funds sit in their account and earn interest rather than allowing the government to benefit from this interest. A person should only pay federal taxes when they are due rather than early.
Withholding Adjustments
Taxpayers should review their withholding exemptions every time they change jobs. When they get a significant raise due to this job change, it is essential to review overall withholding. When doing so, look at both federal income tax withholding and state withholding allowances to avoid unpleasant surprises when it is time to pay taxes.
Nobody likes to pay taxes, but they must. Unfortunately, the government cannot operate without these funds at this time. Until this changes, individuals should do everything possible to minimize their tax liability. Careful planning will help them keep more of their funds and use them as they desire.