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Tax Planning for Beginners: 6 Tax Strategy Concepts to Know

Know your bracket, how key tax ideas work, what records to keep and some basic steps you can take to shrink your tax bill.
June 30, 2020
401(k), Income Taxes, IRA, Personal Taxes, Taxes
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Tax planning is the analysis and arrangement of a person’s financial situation in order to maximize tax breaks and minimize tax liabilities in a legal and efficient manner.

Tax rules can be complicated, but taking some time to know and use them for your benefit can change how much you end up paying (or getting back) in April. Here are some key tax planning and tax strategy concepts to understand before you make your next money move.

1. Tax planning starts with understanding your tax bracket

You can’t really plan for the future if you don’t know where you are today. So the first tax planning tip is get a grip on what federal tax bracket you’re in.

  • The United States has a progressive tax system. That means people with higher taxable incomes are subject to higher tax rates. People with lower taxable incomes are subject to lower tax rates.
  • There are seven federal income tax brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%.
  • No matter which bracket you’re in, you probably won’t pay that rate on your entire income. There are two reasons:
  1. You get to subtract tax deductions to determine your taxable income (that’s why your taxable income usually isn’t the same as your salary or total income).
  2. You don’t just multiply your tax bracket by your taxable income. Instead, the government divides your taxable income into chunks and then taxes each chunk at the corresponding rate.

For example, let’s say you’re a single filer with $32,000 in taxable income. That puts you in the 12% tax bracket for the 2019 tax year. But do you pay 12% on all $32,000? No. Actually, you pay 10% on the first $9,700; then you pay 12% on the rest.  If you had $50,000 of taxable income, you’d pay 10% on that first $9,700 and 12% on the chunk of income between $9,701 and $39,475. And then you’d pay 22% on the rest.

» MORE: See what tax bracket you’re in

2. The difference between tax deductions and tax credits

Tax deductions and tax credits may be the best part of preparing your tax return. Both reduce your tax bill, but in very different ways. Knowing the difference can create some very effective tax strategies that reduce your tax bill.

  • Tax deductions are specific expenses you’ve incurred that you can subtract from your taxable income. They reduce how much of your income is subject to taxes.
  • Tax credits are even better — they give you a dollar-for-dollar reduction in your tax bill. A tax credit valued at $1,000, for instance, lowers your tax bill by $1,000.
* Example rate only. The United States uses a progressive tax system.
Would you rather have:
A $10,000 tax deduction……or a $10,000 tax credit?
Your AGI$100,000$100,000
Less: tax deduction($10,000)
Taxable income$90,000$100,000
Tax rate*25%25%
Calculated tax$22,500$25,000
Less: tax credit($10,000)
Your tax bill$22,500$15,000

» MORE: See a list of 20 common tax breaks

3. Taking the standard deduction vs. itemizing

Deciding whether to itemize or take the standard deduction is a big part of tax planning, because the choice can make a huge difference in your tax bill.

What is the standard deduction?

Basically, it’s a flat-dollar, no-questions-asked tax deduction. Taking the standard deduction makes tax prep go a lot faster, which is probably a big reason why many taxpayers do it instead of itemizing.

Congress sets the amount of the standard deduction, and it’s typically adjusted every year for inflation. The standard deduction that you qualify for depends on your filing status, as the table below shows.

Filing status2019 tax year2020 tax year
Married, filing jointly$24,400$24,800
Married, filing separately$12,200$12,400
Head of household$18,350$18,650

What does ‘itemize’ mean?

Instead of taking the standard deduction, you can itemize your tax return, which means taking all the individual tax deductions that you qualify for, one by one.

  • Generally, people itemize if their itemized deductions add up to more than the standard deduction. A key part of their tax planning is to track their deductions through the year.
  • The drawback to itemizing is that it takes longer to do your taxes, and you have to be able to prove you qualified for your deductions.
  • You use IRS Schedule A to claim your itemized deductions.
  • Some tax strategies may make itemizing especially attractive. If you own a home, for example, your itemized deductions for mortgage interest and property taxes may easily add up to more than the standard deduction. That could save you money.
  • You might be able to itemize on your state tax return even if you take the standard deduction on your federal return.
  • The good news: Tax software or a good tax advisor can help you figure out which deductions you’re eligible for and whether they add up to more than the standard deduction.

» MORE: Find the right tax software for your tax situation this year

4. Being aware of popular tax deductions and credits

There are hundreds of possible deductions and credits out there, and they all have their own rules about who’s allowed to take them. Here are some big ones (click on the links to learn more).

Tax break
What it’s generally for
Adoption creditCosts of adopting a child
American Opportunity creditCollege education costs
Capital loss deductionLosses on stock sales (to offset capital gains)
Charitable contributionsGiving money, cars, art, investments, household items or other things to charity
Child and dependent care creditDay care and similar costs
Child tax credit
Being a parent
Credit for the Elderly or the DisabledFor people or their spouses who retired on permanent and total disability
Earned Income Tax CreditMoney for people below certain adjusted gross incomes
Home office expensesA portion of your mortgage or rent; property taxes; utilities, repairs and maintenance; and similar expenses if you work from home
Lifetime Learning creditUndergraduate, graduate or even non-degree courses at accredited institutions
Medical expensesUnreimbursed medical costs over a certain threshold
Mortgage interest
The interest portion of mortgage payments on a primary home
Property taxesProperty taxes on real estate
Residential energy tax creditsInstalling things that make a home energy-efficient
Saver’s creditContributions to an IRA for people with incomes below certain thresholds

5. Knowing what tax records to keep

Keeping tax returns and the documents you used to complete them is critical if you’re ever audited. Typically, the IRS has three years to decide whether to audit your return, so keep your records for at least that long. You also should hang onto tax records for three years if you file a claim for a credit or refund after you filed your original return.

Keep records longer in certain cases — if any of these circumstances apply, the IRS has a longer limit on auditing you:

  • Six years: If you underreported your income by more than 25%.
  • Seven years: If you wrote off the loss from a “worthless security.”
  • Indefinitely: If you committed tax fraud or you didn’t file a tax return.

» MORE: See more about how long to keep your tax records

Expenses & deductions
  • Receipts.
  • Invoices.
  • Alimony paid.
  • Statements from charities.
  • Gambling losses.
Retirement accounts
  • Form 5498 (IRA contributions).
  • Form 8606 (nondeductible IRA contributions).
  • 401(k) statements.
  • Distribution records.
  • Annual statements.
Other investments
  • Transaction data (including individual purchase or sale receipts).
  • Annual statements.

6. Tax strategies to shelter income or cut your tax bill

Deductions and credits are a great way to cut your tax bill, but there are other tax planning strategies that can help keep the IRS’ hands off your money. Here are some popular tax planning strategies.

Tweak your W-4

A W-4 tells your employer how much tax to withhold from your paycheck. Your employer remits that tax to the IRS on your behalf.

Generally, the more allowances you claim on your W-4, the less money will be taken out of your pay to go toward taxes. Claim fewer allowances on your W-4, and more of your pay should appear on your check.

Here’s how to use the W-4 for tax planning.

  • If you got a huge tax bill in April and don’t want to relive that pain, you may want to increase your withholding. That could help you owe less (or nothing) next April.
  • If you got a huge refund last year and would rather have that money in your paycheck throughout the year, do the opposite and reduce your withholding.
  • You probably filled out a W-4 when you started your job, but you can change your W-4 any time. Just download it from the IRS website, fill it out and give it to your human resources or payroll team at work.

» MORE: Learn how FICA and other payroll taxes work

Put money in a 401(k)

Your employer might offer a 401(k) savings and investing plan that gives you a tax break on money you set aside for retirement.

  • The IRS doesn’t tax what you divert directly from your paycheck into a 401(k). For 2019, you can funnel up to $19,000 per year into an account. If you’re 50 or older, you can contribute up to $25,000. In 2020, those limits rise to $19,500 and $26,000, respectively.
  • While these retirement accounts are usually sponsored by employers, self-employed people can open their own 401(k)s.
  • If your employer matches some or all of your contribution, you’ll get free money to boot.

» MORE: Calculate how much you should put in your 401(k)

Put money in an IRA

Outside of an employer-sponsored plan, there are two major types of individual retirement accounts: Roth IRAs and traditional IRAs.

You have until the April tax deadline to fund your IRA for the previous tax year, which gives you extra time to do some tax planning and take advantage of this strategy.

  • The tax advantage of a traditional IRA is that your contributions may be tax-deductible. How much you can deduct depends on whether you or your spouse is covered by a retirement plan at work and how much you make. You pay taxes when you take distributions in retirement (or if you make withdrawals prior to retirement).
  • The tax advantage of a Roth IRA is that your withdrawals in retirement are not taxed. You pay the taxes upfront; your contributions are not tax-deductible.
  • Earnings on your investments grow tax-free in a Roth and tax-deferred in a traditional IRA.

This table illustrates these accounts in action.

Roth IRA
Traditional IRA
Contribution limit
2020 and 2019: $6,000 ($7,000 for those 50 and above).

2018: $5,500 ($6,500 for those age 50 and above).
Key pros
  • Qualified withdrawals in retirement are tax-free.
  • Contributions can be withdrawn at any time.

    • If deductible, contributions reduce taxable income in the year they are made.

    Key cons
  • No immediate tax benefit for contributing.
  • Ability to contribute is phased out at higher incomes.
  • Deductions may be phased out.
  • Distributions in retirement are taxed as ordinary income.
  • Early withdrawal rules
  • Contributions can be withdrawn at any time, tax- and penalty-free.
  • Unless you meet an exception, early withdrawals of earnings may be subject to a 10% penalty and income taxes.
  • Unless you meet an exception, early withdrawals of contributions and earnings are taxed and subject to a 10% penalty.
  • » MORE: How to find the right kind of IRA for you

    Open a 529 account

    These savings accounts, operated by most states and some educational institutions, help people save for college.

    • You can’t deduct contributions on your federal income taxes, but you might be able to on your state return if you’re putting money into your state’s 529 plan.
    • There may be gift-tax consequences if your contributions plus any other gifts to a particular beneficiary exceed $15,000 in 2019 or in 2020.

    » MORE: Learn more about how 529s work

    Fund your flexible spending account (FSA)

    If your employer offers a flexible spending account, take advantage of it to lower your tax bill. The IRS lets you funnel tax-free dollars directly from your paycheck into your FSA every year; the limit is $2,700 for 2019 and $2,750 for 2020.

    • You’ll have to use the money during the calendar year for medical and dental expenses, but you can also use it for related everyday items such as bandages, pregnancy test kits, breast pumps and acupuncture for yourself and your qualified dependents. You may lose what you don’t use, so take time to calculate your expected medical and dental expenses for the coming year.
    • Some employers might let you carry over up to $500 to the next year.

    Use Dependent Care Flexible Spending Accounts (DCFSAs)

    This FSA with a twist is another handy way to reduce your tax bill — if your employer offers it.

    • The IRS will exclude up to $5,000 of your pay that you have your employer divert to a Dependent Care FSA account, which means you’ll avoid paying taxes on that money. That can be huge for parents of kids under 13, because before- and after-school care, day care, preschool and day camps usually are allowed uses. Elder care may be included, too.
    • What’s covered can vary among employers, so check out your plan’s documents.

    Maximize Health Savings Accounts (HSAs)

    Health savings accounts are tax-exempt accounts you can use to pay medical expenses.

    • Contributions to HSAs are tax-deductible, and the withdrawals are tax-free, too, so long as you use them for qualified medical expenses.
    • If you have self-only high-deductible health coverage, you can contribute up to $3,500 in 2019. If you have family high-deductible coverage, you can contribute up to $7,000. Your employer may offer an HSA, but you can also start your own account at a bank or other financial institution.
    • In 2020, you can contribute up to $3,550 if you have self-only high-deductible health coverage. You can contribute up to $7,100 if you have family high-deductible coverage.

    » MORE: See the tax benefits of FSAs and HSAs

    See more ways to save and invest for the future


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