Tax Planning

The goal of tax planning is to minimize your overall tax liability. Some of the most common planning techniques involve deferring taxes, sheltering income, and itemizing deductions.

Tax Shelter & Tax Deferral

Employer-provided qualified plans represent a particularly effective method of deferring the payment of taxes on your earned income. There are numerous varieties of such plans (one of which is the 401(k) plan), and numerous methods of contributing to such plans. Typically, a portion of your salary is deposited (by your employer) into the plan; you pay taxes on this portion (plus the earnings) only when you take a distribution from the plan. Thus, you are able to defer the taxation of part of your salary, and are able to take advantage of the tax-free build-up of your investment earnings.

Contributions to a traditional IRA can also be tax deductible if you meet the applicable requirements. If an IRA contribution is tax deductible, then you may lower your AGI by the amount of the contribution. Essentially, you are deferring the taxation of your contribution until you withdraw that money from your IRA account at some future point. Thus, the traditional (deductible) IRA allows you to shelter your earned income from current taxation. The earnings that accrue on your contributions also grow tax free until you take an IRA distribution.

Itemizing Deductions

You subtract certain deductions from your adjusted gross income (AGI) to determine your taxable income. You can subtract either the standard deduction or itemized deductions. The standard deduction is a fixed dollar amount determined according to your filing status and circumstances. Itemized deductions are the various deductions that are reported on Schedule A of Form 1040. Itemized deductions include medical and dental expenses, mortgage interest, state and local taxes, charitable deductions, and casualty and theft losses. In most cases, you must decide whether taking the standard deduction or itemizing your deductions will be more beneficial.

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