Don’t wait until you’re close to the filing deadline before you think about personal income tax! Keep reading and learn to save money with tax credits, tax deductions, and these tips.
In this article:
- Know What Personal Income Tax Is
- Compare Your Current and Future Finances
- Donate to Charities
- Mind Your Traditional IRA Contributions
- Deduct Your Business Expenditures
Personal Income Tax Guide | Tips to Save on Taxes
1. Know What Personal Income Tax Is
What is a personal income tax? It is the tax levied on the individual for different types of income received within a specific tax year. These can include compensation or salary, stock options, and fringe benefits. Fees for services, rental income, and capital gains also count. You may also receive unearned income such as Social Security payments.
It is a percentage of the taxable income or the adjusted gross income. You obtain it by reducing gross income with adjustments or tax deductions.
The U.S. personal income tax rates follow a multi-tiered system known as income tax brackets. Furthermore, a person may have to pay both federal personal income tax and local income taxes. The rates that apply can also significantly vary. There are also some states with no personal tax, but they may levy higher rates for other taxes. These include property tax, which is a tax on personal property such as a house.
Personal income tax is different from corporate income taxes of corporations. The amount to pay depends on the business income.
2. Compare Your Current and Future Finances
Start by gathering all your data from January to December this year. This includes your income, expenses, and savings. Follow it by estimating their amounts for the next year. Finally, compare your current and future finances. See whether you fall on a higher personal income tax bracket within the forecast period.
If you belong to higher personal income tax brackets in this tax year, consider deferring your remaining income until after December. It can help balance your taxes due. It is also a legal way to ease the economic burden if you end up in two different tax brackets. If you are trying to lower your taxes this year, defer as much income as possible to next year.
3. Donate to Charities
Donating to charities has a higher purpose, and it may include lowering your personal income tax. You can donate either property or cash to a tax-exempt or qualified charity such as a church. The limit is between 30% and 60% of the adjusted gross income (AGI) if it’s cash. Real property donations are only up to 30% of your AGI.
Note a few important things, though. A donation tax deduction is different from a gift tax exemption. The latter doesn’t affect your personal income tax unless you exceed the exclusion amount. Based on the new tax law, it’s already $15,000 each year per recipient.
Second, a donation to a charity is one of the itemized deductions. It means it requires a separate IRS form such as Tax Form 8283. You submit it with your income tax return if the total value of all donated properties exceeds $500. Properties are according to their fair market value (FMV). It refers to the price the asset would sell if it’s in the market. You also need to be diligent in keeping records of your donations. These can include the receipts, canceled checks, and proof of direct deposit.
Third, the new tax reform act introduced a massive change in the standard deduction. It almost doubled compared to the previous year, depending on your filing status:
- Single taxpayers and married couples filing separately can claim $12,000.
- For married filing jointly, they can claim $24,000.
- A taxpayer who’s head of household can claim $18,000.
These amounts matter since you cannot claim a donation tax unless all itemized deductions exceed the standard. If you need suggestions, work closely with a tax specialist or tax preparer.
4. Mind Your Traditional IRA Contributions
If you’re making contributions to a Traditional Individual Retirement Account (IRA), you can use them to lower your taxes. How much you can deduct depends on your modified adjusted gross income (MAGI). It refers to your AGI less interest income that is tax exempt. In general, the maximum contribution for individuals under 50 years old is $5,500. Those who are beyond that age can make a catch-up contribution of an additional $1,000. The total itemized deduction, thus, is $6,500.
Keep in mind this is only a tax deferment. Once you hit 70.5 years old, you need to make minimum distributions or withdrawals. These will be subject to ordinary income tax rates.
These deductions are different from tax credits. The latter can lower the income tax liability, not the taxable income.
5. Deduct Your Business Expenditures
If you’re operating a business in your home, you can lower your personal income tax with company-related costs. These can include a part of the house converted into a home office, electricity, or the Internet. To qualify, these expenses should be deemed ordinary and necessary.
Calculating the possible business tax deductions can be complicated. For example, if you want to declare a home office expense, you need to know the square footage of the area. You can follow a simplified method and be diligent in maintaining records of expenses.
A small business, particularly a sole proprietorship, may take advantage of the pass-through system. In this setup, the business doesn’t pay tax but passes it on to the income tax return. It can prevent double taxation and lower taxes. You may deduct 20% of the qualified business income (QBI). It can refer to the person’s investments on the payroll to the employees and capital assets of the business.
You can also increase your business expenditures by year-end. One example is to give the annual bonuses to your employees before December is over. You can also make advance bulk purchases. It makes your expenses for the first few months of the succeeding year tax deductible in the current year.
Calculating and planning for personal income tax can be time-consuming and challenging. You may need help from an expert in tax preparation at a certain point. The deductions, possible tax refund, and, most of all, tax relief, though, can make it all worth it.
Do you have other personal income tax tips and tricks we might have missed? Share it with us in the comments section below.
Up Next: Self Employment Tax Rates | Business Tax Deduction
Editor’s Note: This article was originally published on November 9, 2017, and has been updated for quality and relevancy.