You actually have more control over your tax bill than you might think, and proper planning may help reduce what you owe or increase your refund when it comes time to file!
In particular, taxpayers who have had changes in their employment this year are more likely to have changes to their tax situation and may benefit from exploring how their tax return will be impacted.
Understanding tax brackets
Knowing your tax bracket and how your taxes will be calculated can help you better plan for your tax filing situation.
A tax bracket is determined by a taxpayer’s filing status as well as taxable income, meaning the total of all income from all sources, less any adjustments, deductions and certain credits.
According to the IRS, the standard deduction for married filing jointly rises to $24,800 for tax year 2020, up $400 from the prior year. For single taxpayers and married individuals filing separately, the standard deduction rises to $12,400 in for 2020, up $200, and for heads of households, the standard deduction will be $18,650 for tax year 2020, up $300.
For tax year 2020, the top federal tax rate remains at 37% for individual single taxpayers with incomes greater than $518,400 ($622,050 for married couples filing jointly). The other rates are:
35% for income over $207,350 ($414,700 for married couples filing jointly);
32% for income over $163,300 ($326,600 for married couples filing jointly);
24% for income over $85,525 ($171,050 for married couples filing jointly);
22% for income over $40,125 ($80,250 for married couples filing jointly);
12% for income over $9,875 ($19,750 for married couples filing jointly).
The lowest rate is 10% for incomes of single individuals with incomes of $9,875 or less ($19,750 for married couples filing jointly).
State income tax rules and regulations will vary from state to state. While some states have no income tax, others have a flat rate structure. Some states have tax brackets similar to the federal tax bracket structure, with varying marginal tax rates.
Year-round tax planning
Keeping track of important tax records
Gathering and organizing tax-related items throughout the year will make it easier when it comes time to file your taxes. These items should include your paystubs, charitable donations, contributions to retirement accounts – like an IRA and 401(k). A new document to watch out for and keep this year is the IRS Letter 1444, which has your stimulus payment information. It’s recommended that you keep these documents, as well as past tax returns, for seven years.
Life changes can impact your income tax return
Big life changes like getting married, retiring, having or adopting a child, and buying a home can have a big impact on your tax return. Many of these life changes provide taxpayers with important tax credits and deductions. Learn how life changes might impact your income taxes.
Adjusting your W-4 tax withholding
The IRS form W-4 allows employers to compute how much federal income tax to withhold from your paycheck. On this form you indicate your filing status, add other income outside the job you are completing the form for and include the number of dependents for the Child Tax Credits and the Credit for Other Dependents.
If you withhold too much, you’ll likely take home less in your paycheck but possibly owe less or get a larger refund when you file. If you withhold too little, you’ll take home more money in your paycheck, but get a smaller refund or maybe owe taxes when you file next year. Learn more about how to adjust your withholdings.
Understanding the difference between credits and deductions
What may be eligible for credits and deductions changes year to year, so be aware of what’s available for the current tax year. Plus, your situation may have changed due to life changes or COVID-19, and that can impact your taxes too. For example, the Earned Income Credit, or EITC, is a tax credit that can reduce your taxes or increase your tax refund dollar for dollar – which is different from a tax deduction that reduces your taxable income.
But, what does it really mean to “take a deduction?” Taking a deduction on your tax return means you reduce your income that is subject to taxes. When it comes to the main deductions, you can either take the standard deduction, an amount set by law or, if larger, itemize your deductions - a total of specific deductions such as medical expenses, mortgage interest, certain taxes and charitable contributions.
A tax credit is perhaps one of the most valuable items on your tax return, because – unlike a deduction – it actually reduces your taxes owed dollar for dollar, making it more valuable, and sometimes, it’s even refundable meaning if you don’t owe tax, you can get those dollars in the form of a refund.
To recap: Deductions reduce your income before you calculate taxes. Credits are a dollar for dollar reduction in taxes, meaning a dollar of credit is worth a dollar off the taxes and a dollar of deduction reduces your income by a dollar.
Taxpayers have the option to either take the standard deduction or itemize, whichever is larger. This year, the standard deduction is $12,400 for single filers and married filers filing separately, $24,800 for married filers filing jointly and $18,650 for heads of household. Read more about filing jointly vs separately.
Considering other ways to save on your tax bill
Investing in your retirement accounts can help lower your taxable income. Retired taxpayers can typically have investments in many different retirement accounts, ranging from IRA’s, 401(k)s from various jobs, company plans, and just plain old savings.
Furthermore, contributing to a Health Savings Account can also help you lower your taxable income. An HSA is a tax-exempt account used to pay or reimburse qualified medical expenses that generally would be eligible for the medical and dental expenses deduction. Contributions to an HSA grow interest tax free, and the account stays with you even if you change employers or leave the workforce. Unused funds carry over to the next year and there is no time limit on when the funds must be used, unlike a Flexible Spending Account, where funds are forfeited at the end of the year. You must have a high deductible health plan (health insurance) to be eligible to make contributions to an HSA.
Mid-year tax planning tips
Now that we’re halfway through 2020, and so much has changed since the beginning of the year, many taxpayers will find that now is a great time to do a mid-year checkup to see how those changes may have impacted their tax situation this year.