While you are gathering the forms, statements, bills, receipts and other information needed to complete your 2002 income taxes, do you ever wonder where did the money go? Does your tax return usually have a sizeable refund or significant amount due? Did you do any tax planning during the previous year? Is it time for you to consider building a tax plan for 2003?
A good tax strategy is to have a completed tax return with a minimal refund available or a small amount owed. A sizeable refund available means that the government has used your money without the benefit of interest or other potential earnings. A significant amount due may cause you to owe penalties and interest in addition to the tax.
If you work through the following steps, you will be well on your way to having a tax plan for 2003.
Step 1 – Review what happened in 2002. Figure out where your money came from and where it went. As you gather your records together to complete your 2002 income taxes, note how much income your household earned. Also note how much and where your costs were spent and how much income tax you paid. Using an accounting software package to pay your bills and balance your checkbook simplifies this step.
Step 2 – Determine your tax liability or refund for 2002. If you are receiving a sizeable refund or owe a significant amount then you should adjust the amounts being paid to the IRS. Employees should request a Form W-4 from their employer and recalculate their withholding exemptions. By claiming more exemptions on Form W-4, the employer will withhold less income tax from the paycheck. Or, by claiming fewer exemptions, the employer will withhold more income tax from the paycheck. Self-employed taxpayers that either owe significant amounts at the end of the year, or have a sizeable refund due should review how they are calculating their quarterly estimated payments. Compare your self-employment income and expenses from your 2002 return with the amounts used in calculating the quarterly estimates. When preparing the quarterly estimates, make sure you take into account a reasonable estimate for other income (like interest received, dividends and capital gains) and other deductible expenses (like interest paid, real estate taxes, charitable contributions, IRA contributions, and child care credits). Remember, a large refund might be nice, but the IRS does not pay you interest on your overpayments. Likewise, a large year-end payment could be cause for penalties and interest owed to the IRS.
Step 3 – Plan for 2003. Estimate what you think your earnings will be for the current year. Take the deductions allowed on the 2002 return and calculate what you would owe if your estimated income number is accurate. Compare the tax bracket you were in for 2002 with the tax bracket you estimate for 2003. Is one year higher than the other? If so, would you have benefited by deferring income from 2002 to 2003? How about shifting deductions from one year to the other? Did you maximize your capital loss deduction? Did you take full advantage of the charitable giving deduction?
Step 4 – Review and update your plan during the year. Wouldn’t it have been nice to know your tax bracket for 2002 during 2002? That way if you knew the current year tax situation would be different from the next years tax situation, you could have taken steps to maximize your deductions and minimize your effective tax rate.
An example is that you predict next year your business income will be fifty percent higher than this year’s income. So next year you will be subject to a higher tax bracket. Is there a way for you to shift income from next year to this year? Can you defer deductions from this year to next year? Can you manage your portfolio of investments to have net gains in this year and net losses next year?
Tax planning can work to your advantage only if you have a strategy and you have a reasonable estimate of your taxable income before the year is over. Waiting until April to think about how to lower last year’s taxes will not be beneficial. Talk to your tax preparer about your individual situation. Remember, to get the most out of your car or house you need to do preventative maintenance. Why not do some preventative maintenance on your tax situation so that you can maximize your earnings and receive the greatest benefit from your deductions.
