5 Ways to Plan Ahead for Tax Season Now

Taxes are an unpleasant fact of life for most people, but planning ahead can make the task a little easier. Addressing each of the following areas can also help you legally minimize your taxes and leave more money in your pocket.

1. Minimize Taxable Income

Taxes are based on the income an individual earns each year, but not all cash a person receives is treated the same way. “There are numerous tax laws that individuals need to take into account when trying to plan the best way to manage their tax liability,” said Bill Rivero, a partner at accounting firm Correia, Rivero and LeFebvre. “An accountant or tax professional can help with this problem.”

One way you can minimize your tax liability is to shift as much income into long-term capital gains as possible. Investment assets held for more than 365 days are generally taxed at a much lower rate than ordinary income or short-term capital gains (those held for less than 365 days). This reality can influence investment choices for many individuals.

Individuals whose income varies from year to year might want to consider shifting some of that income to the next calendar year to more evenly distribute their income over time. This can help you avoid paying very high tax rates one year and then very low tax rates the next year. For instance, salespeople and those working on commission or expecting a bonus can ask their employers to defer a December payment until January. In some cases, waiting a couple extra weeks for a check can mean thousands of dollars in tax savings.

Read: 7 Tax Strategies the Rich Don’t Want You to Know About

2. Maximize 401k Contributions

A 401k plan ranks as one of the best ways to manage one’s tax liability, but it requires some advance planning. An individual can contribute up to $18,000 of pretax income to a qualified 401k plan each year, and when it’s matched by an employer, the individual gets an automatic 100 percent return on their investment. The catch with 401k plans is that since the money is intended for retirement, it can’t be withdrawn until the individual is 59½ years old. Any funds withdrawn before that time face hefty fines and taxes from the IRS.

However, not everyone has access to a 401k plan, and some people who do might not take full advantage of it because they want to save more than $18,000 annually. For those facing that dilemma, maximizing deductions is critical. Some of the most important and common tax deductions include those for mortgage interest, student loan interest, charitable contributions, union dues and foreign taxes. Smart planning can help you identify and take advantage of all the deductions for which you’re eligible.

3. Maximize Tax Credits

Although tax deductions lower one’s taxable income, they do not lower taxes as much as tax credits do. A $100 deduction for a person at the 25 percent rate will lower tax liability by $25. In contrast, a $100 tax credit lowers tax liability by $100.

Tax credits vary from year to year, and small business owners can take advantage of several credits not available to most individuals. Still, there are tax credits even the average employee can take advantage of with proper planning.

Common tax credits include the earned income tax credit, the American opportunity tax credit and the child tax credit. Under the child tax credit, individuals are given up to a $1,000 credit for each qualifying child under the age of 17. This credit only applies to individuals with incomes under $110,000 for married couples and under $75,000 for those filing individually. The earned income tax credit applies to those with low incomes. The credit is a bit complex, but is summarized in the chart below, courtesy of the IRS.

If filing…Qualifying Children Claimed
ZeroOneTwoThree or more
Single, Head of Household or Widowed$14,880$39,296$44,648$47,955
Married Filing Jointly$20,430$44,846$50,198$53,505

Finally, the American opportunity credit is available to people who have college education expenses and whose modified adjusted gross income is $80,000 or less, or $160,000 or less for married couples filing jointly. The credit can be worth up to $2,500, but the value drops as an individual’s income increases.

Related: 5 Tax Law Changes for 2016 You Need to Know

4. Evaluate Insurance Choices

Under the Affordable Care Act, all individuals are required to carry health insurance, or pay extra taxes. As with almost everything related to taxes and the government, calculating the amount of the payment owed requires a little work, but the IRS does have tools to help.

Planning ahead for tax season and deciding on insurance coverage for 2016 is very important. Even for those who plan to carry health insurance, it is important to ensure that the plan you will use qualifies under ACA guidelines otherwise you will still owe extra taxes in the future.

5. Compile Tax Forms

Finally, after you have done everything you can to minimize your taxes, one of the most important final steps in preparing for tax season is to get the materials together that you need to file. There are numerous tax forms that can apply in many different situations, but there are certain forms that are most common for the average filer. Not everyone will need all of the tax forms from the list below, but many people will have multiple items on this list to compile.

W-2 form: Anyone who is employed in a full-time job should get a W-2 from their employer. The IRS requires employers to generate and mail the form to employees each tax year.

1099-MISC: Individuals who work as a contractor or a freelancer need to make sure they receive a 1099-MISC.

1099-INT: Individuals who earn interest from banks and financial accounts need to get a 1099-INT, which shows the IRS the interest the individual has received for the year.

1099-DIV: Similar to the 1099-INT, the 1099-DIV form comes to individuals who get dividend income in a given year, generally from a stock brokerage account.

1099-B: While dividend income is reported on the 1099-DIV, capital gains income or losses from stock trades are reported on a form 1099-B.

K-1: Most stocks that pay dividends are standard corporations, but for certain special types of businesses, like master limited partnerships, dividend payments are filed on a K-1 form. The tax treatment on this income is different, so be sure to consult an accountant or tax professional if you receive a K-1.

1098: Individuals with a mortgage on a house or condo should receive a form 1098 from their bank. This form tells the government how much mortgage interest was paid by the individual for the year. That mortgage interest is an important deduction for those who are eligible.

1098-E: Similar to interest paid on mortgages, interest paid on student loans is also tax deductible. Form 1098-E reports the interest paid on any outstanding student loans an individual has.

Read: 5 Ways to Defend Yourself Against Financial Bullies

About the Author

Michael McDonald is an assistant finance professor and consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance and his research has been quoted in the Wall Street Journal and Bloomberg. He provides corporate consulting through Connecticut Expert Witness Consulting and teaches classes in the areas of corporate finance and investments.