[Easy] 5 Steps To Build Your Tax Plan (2024)

For most individual and business taxpayers, managing their tax liabilities is quite a macro-problem. Given the current structure of tax laws, which are a bit too complicated and change continuously, non-compliance comes with a certain amount of risk. Not being able to understand the rules bears penalties on an individual’s finances and lost opportunities for tax savings, thus making the whole finance inefficient.

Effective tax planning offers a robust solution to the management and optimization of tax liabilities. It helps individuals and businesses comply with internal revenue laws while fully benefiting from available tax benefits through comprehensive tax planning. It is a precautionary measure for pinning down avenues by which tax savings through deductions, credits, and sundry tax-advantaged strategies can be achieved.

Secondly, tax planning arranges long-term financial strategies by pointing out the taxes that are at work in coordination with the financial goals. It gives one clarity and foresight, thereby enabling better cash flow management and financial stability for businesses and individuals. Results include increased efficiency in finance, lessening of the tax burden, and improvement in the state of health of the finances.

It’s, therefore, the most crucial tool in maneuvering through the complexities of the tax system to ensure compliance and financial success. Strategic management of tax liabilities will help people and businesses realize higher chances of financial success and long-term stability.

As we go into the wind-down towards the end of 2021, it is imperatively critical to have a tax plan developed before the tax season picks up. This helps you to be very proactive in managing your tax liabilities with no surprises. Herein, we will walk you through the steps for creating a comprehensive tax strategy that covers everything from understanding your tax bracket to implementing various tax-saving strategies. Whether you are a rookie or a seasoned tax planner, these steps will put you on your way toward taking control of your tax situation.

5 Steps To Build Your Tax Plan (2024)

Step 1: Calculate Your Income Tax Bracket.

Knowing your tax bracket is the first step toward a tax plan. If you don’t know where you are, then how can you have a plan for where you’re going? In the United States, we have a progressive tax system. This means that the more money you make, the more of it the government will take in tax.

Say, for example, that you make $100,000. The wrong thing that most people will do with this figure is multiply it by 24 percent—the tax rate for their bracket—and assume that they have to pay $24,000 in taxes. The IRS slices up your income and applies different rates to different pieces. Thus, only part of your income will be hit with the maximum rate that is imposed on you. Keeping that in mind helps in making a good estimate of your tax burden.

For instance, if your household earned $100,000 of taxable income, only $13,624 would be taxed at the 24% tax rate. After factoring in the standard deduction, you would owe about $15,103 in taxes when all was said and done—not the $24,000 you might assume based on this flat analysis. Quite a difference, and it really makes a case for why you need to understand your tax bracket.

Step 2: Understand Tax Deductions and Credits

Tax deductions and credits can be very vital in decreasing your taxable income and, in due course, the corresponding income tax liability. By default, every American household is responsible for a standard deduction; for the tax year 2021, that’s $12,550 if filing single, while married couples that decide to file jointly have a basic deduction of $25,100 and heads of households have an $18,800 deduction. But you are entitled to itemizing if your qualified expenses are more than the standard deduction.

Tax deductions reduce your income that is taxable; tax credits reduce the actual tax bill dollar for dollar. For example, a $3,000 tax deduction on $48,000 of income brings it down to $45,000 of income, saving you perhaps $350 off your tax bill. A $1,000 tax credit cuts a full $1,000 off your tax bill. Obviously, tax credits are far more valuable.

Proper tax planning means that you understand your deductions and credits available to you. Some of the normal, or everyday, tax deductions include mortgage interest, property taxes, and charitable donations. The Child Tax Credit, Earned Income Tax Credit, and education credits are sources of tax credits. As an example, each can significantly cut your tax liability.

Step 3: Calculate Your Tax Liability After Deductions and Credits

Base your estimate of your tax liability on your understanding of your tax bracket and the deductions and credits available to you. All it boils down to is determining your taxable income after the application of all relevant deductions and credits.

The two major questions that you need to ask yourself are:

Are you satisfied with your current tax outcome? You may find, as you get to the calculation itself, most of you will come out and find you’re paying very little taxes and nothing really you need to do much different. Or, perhaps you are comfortable with how high your actual tax rate is and feel you’re giving your fair share.

Is that OK with you, for example, taking less income home today for future tax benefits? Most sophisticated tax strategies are based on the deferral of income and acceleration of expenses. Essentially, this means that you can have less home income now but have lower taxes in your future. Check to see if that approach fits your financial goals, and see if it will work out in your current situation.

These are the questions you need to answer in order to decide whether any changes in your tax strategies are necessary. When you are adequately satisfied with your tax outcome and don’t need to make any major changes—okay. But if you really want to reduce your tax liability further, there are a number of tax strategies you need to consider.

Step 4: Your Tax Strategies

Depending on your tax liability, you may need one or multiple tax strategies. Here are three of the most effective tax strategies to consider:

Start or Invest in a Business: Starting or investing in a new business most of the time includes startup costs, which generally lead to business losses. Such losses can be used as deductions against your taxable income. For example, if you were to spend $20,000 on startup costs, it would considerably bring down the amount of your taxable income. It is not only a way of saving on taxes, but also a means to create an asset of ultra-high value.

Contribute to a 401(k) or IRA: Contributions to these retirement accounts are tax-deferred, so you don’t need to pay them now. By the time retirement comes, this strategy could save you significant amounts of taxes. Take the case where contributing $19,500 to a 401(k) reduces taxable income by that amount. Over time, tax-deferred growth inside these accounts might be very substantial in savings.

Max Out Health Savings Accounts: HSAs are tax-free savings accounts for paying medical bills. Contributions toward HSAs are tax-deductible, and one withdraws the money to spend on various kinds of medical expenses with huge income tax savings. In 2021, individuals with high-deductible health plans can contribute as much as $3,600, and families can contribute up to $7,100. These contributions lower your taxable income and provide you with a nice source of funding for future funds needed for medical expenses.

Step 5: Execute your tax plan

Now that you understand how much your tax liability is, the deductions, credit, and implementation of the strategies, it is time you execute the plan. The execution of the plan means you do the required calculations, open the required accounts, and make financial adjustments in respect of your tax strategy.

For instance, if you take benefits of a 401(k) or an IRA, ensure that you open them and funding your accounts consistently. If you start a business, track every expense to be able to deduct these expenses maximally. If you use an HSA, understand qualifying expenses, and contribute to it as much as the law allows.

Conclusion

Follow these steps to build a comprehensive tax plan that will help you manage your liabilities effectively and stay ahead of your taxes. Be proactive, and make sure you get all the deductions and credits available. If you need more information on specific tax strategies, refer to related videos on the links below.

Design a good tax plan now, and avoid those nasty surprises. Also, make informed decisions about your finances. Subscribe to our channel for more tips on saving taxes and wealth creation; stay tuned for upcoming videos on effective tax strategies.