Income Tax Planning: How to plan your taxes early and minimize your tax outgo

There are two types of taxpayers – those who plan their taxes at the very last minute and are at risk of making certain costly mistakes, and others who start their tax-planning early and are better-positioned to minimise their tax outgo and boost their savings. So, if you’re looking to ensure a smooth tax filing process and save money in tax outgo, you’ll be well-advised to plan your taxes early. Read on as we discuss a few tips on how to go about it.

1. Select the right tax-saving instrument

As you start planning your taxes early, i.e. several months before the current financial year ends, you should try to strike the right balance in terms of choice of tax-saving instruments. You should ideally select tax-saving investments that can help you achieve your financial goals in time. Early planning allows you to carefully evaluate the returns offered by your shortlisted investment products and figure out which ones are aligned with your financial goals and risk appetite and can suffice your liquidity requirements.

For example, if you are close to retirement, you might benefit more by investing in tax-saving debt-oriented investment products that carry minimal risk, like Public Provident Fund (PPF), National Savings Certificate (NSC), among others. On the other hand, if you are young and looking for a high return, you should keep certain equity-oriented tax-saving products like Equity Linked Savings Schemes in your investment portfolio.

It will be pertinent to note here that there are various tax-saving tools that come with a lock-in period of 3 years, 5 years, and even longer, and you can choose as per your financial goals and other considerations.

2. Invest through instalments

A common misconception is early tax planning is synonymous to investing lump-sums in tax-saving instruments. This is not true. In fact, it’s better to invest through instalments to gain rupee cost averaging benefits while keeping liquidity concerns at bay. As you get closer to the end of the financial year, you can increase or seize the investments depending on whether you have exhausted the tax deduction limit under the prescribed Income Tax Act. For example, under section 80C you can invest in the ELSS, PPF, etc. every month.

You need to keep in mind that you don’t exceed the investment threshold allowed under the applicable act for a tax deduction. For example, the deduction threshold u/s 80 C is Rs 1.5 lakh, and if you invest more than this applicable prescribed limit, you won’t get any additional tax benefit on such excess investment.

3. Exhaust the allowances received from the employer

There are several allowances that employers provide to their employees – like food coupons, reimbursements on mobile and internet bills, among others – which can lower your tax liability. By planning early in the financial year, you get sufficient time to utilise these allowances efficiently and reduce the tax outgo. Using tax-saving allowances also helps in alleviating the burden on your financial budget as you can focus on using the fund for other expenses.

4. Estimate your tax obligation and avoid last-minute glitches

Make an estimation of your tax liability for the current financial year and use that estimate to determine your monthly or quarterly tax obligation. It will help you to ascertain how much would be your tax liability at the end of the year, and accordingly, you can fine-tune your tax-saving investment steps every month or quarter. If there is a deviation in income in any month or quarter, you can accordingly increase or decrease your tax-saving investments.

Taking last-minute tax-saving steps can also put you at risk of committing serious and irreversible financial mistakes. So, the better option is to always plan it early and remain stress-free.

 

Important Tax Deadlines

Mark your calendar with these tax filing and retirement account deadlines. Doing so can help simplify your financial life and may help you avoid IRS penalties.

January 31, 2020

• Is the deadline for employers to mail out W-2 Wage and Tax Statements and generally, for businesses to send various Forms 1099, which report non-employee compensation, bank interest, and distributions from a retirement plan, and help calculate your total taxable income. However, extended timelines may apply, resulting in a later mail date.

Feb. 18, 2020

• Is the deadline for businesses to send various Forms 1099 for accounts which include securities and report interest, dividends, capital gains and losses, and other income to help you calculate your total taxable income. However, extended timelines may apply, resulting in a later mail date.

July 15, 2020

• Is the filing and payment date for 2019 federal income tax returns due April 15. You can file electronically or postmark your paper submission by that date.
• The new due date to file an extension to income tax returns is July 15, 2020 (extended from April 15, 2020). The extension only goes to Oct.15, 2020. Payment is still due July 15.
• The new deadline to make your IRA contribution for the 2019 tax year is July 15, 2020.

October 15, 2020

• Individuals who filed for an extension need to file their 2019 federal income tax return by October 15, 2020. Returns filed by mail must be postmarked no later than this date. However, you should estimate and pay any owed taxes by the July 15 deadline to help avoid possible penalties.
• If you are self-employed and filing for an extension for your personal taxes, you will have until the Oct. 15 deadline to file the paperwork for your individual tax return. However, any taxes you owe are still due on July 15.

December 31, 2020

• Is normally the deadline to take required minimum distributions (RMDs) for 2020 tax year, but due to the CARES Act no RMD is required to be taken in 2020.
• December 31 is the last day to convert a Traditional IRA to a Roth IRA for the 2020 tax year.
• The deadline to sell non-qualified securities to realize a gain or loss for the 2020 tax year is December 31, 2020, if appropriate.
• December 31 is the last day to make charitable gifts which may qualify for a federal income tax deduction on your 2020 return.

 

Timing is Everything

Timing can make a big difference when it comes to your year-end tax bill. When you sell assets or pay your debts can make a big difference.

If you look at the investments in your non-retirement accounts at the end of the year, and see which investments are winners and losers, you might want to decide whether to sell these winning or losing investments. Selling those investments can affect your tax situation for the year.  You can use up to $3,000 in short-term losses to offset up to $3,000 of regular income each year. However, you can carry forward unused short-term losses for future use. Figure out which of the investments in your portfolio you want to sell now or later, depending on how it will affect your present and future tax plans.

There are other ways to plan ahead for spending that can help you reduce your tax bill. Charitable contributions can affect your tax bill as well. If your charitable giving doesn’t typically push you above the standard deduction amount, you might want to consider bunching deductions. That essentially means you donate several years’ worth of charitable gifts in a single year, which ends up pushing you above the threshold so you benefit from itemizing your deductions. A tax attorney or another financial professional can help you figure out how to time your giving and how to plan for that.

 

What Is Income Tax

Income tax is a direct tax that a government levies on the income of its citizens. The Income Tax Act, 1961, mandates that the central government collect this tax. The government can change the income slabs and tax rates every year in its Union Budget.

Income does not only mean money earned in the form of salary. It also includes income from house property, profits from business, gains from profession (such as bonus), capital gains income, and ‘income from other sources’. The government also often provides certain leeway such that various deductions are made from an individual’s income before the tax to be levied is calculated.

Income Tax Returns

Income Tax Returns (ITR) form are the basis of calculating a person’s income tax. It is a statement showing the status of a person, all their sources of revenue, deductions and, lastly, the tax payable or tax refund, if any.

Income Tax slabs

What income tax rate a person pays depends on the slab they fall in. The government has categorised incomes into slabs like — up to Rs 250,000, Rs 250,000-Rs 5,00,000, Rs 5,00,000-Rs 1 million, and more than Rs 1 million. The rates on different slabs might be different based on age groups.

Standard deduction

Tax on some components of income can be waived by the government. These tax reliefs are known as standard deductions.

 

Tax Preparation VS. Tax Planning

Many people expect to save the most amounts of taxes by hiring a professional to prepare their tax return. However, you may be surprised to learn that you could probably get some additional tax savings after your professional tax preparer’s work.  Recently, a fellow fee-only financial planner shared a story with us. He reviewed five tax returns prepared by an experienced CPA, and he was able to find extra tax saving opportunities from four out of the five tax returns. Other advisors and I also have the same experience. This week, I am going to explain the difference between tax preparation and tax planning, and how to get some real comprehensive tax planning advice.

First of all, you have to understand that tax preparation and tax planning are different. From a professional perspective, they are technically two different services.

Tax preparation is a service that helps you file your tax returns. The main goal is to make sure your tax reporting complies with both federal and state tax laws.

Tax planning is a service that helps you optimize your tax situation before reporting. The purpose is to use legitimate ways to optimize your potential tax consequences based on your goals and plans for future.

Some professional tax preparers may give you general tax guidance and tax savings advice based on your tax returns for recent years. Or they just answer your specific tax-related questions upon your request. However, many of you may not get proactive tax planning advices from them, such as how to use tax loss harvesting to offset your investment gains, how to manage your tax bracket, how to maximize your charitable deduction in a tax-efficient way, when you should do a Roth conversion, what to do with your stock compensations from the tax perspective, what’s the most tax efficient way to take your money out from all your taxable and retirement accounts, how to strategically qualify for a larger mortgage amount or financial aid from the income perspective, and so on. Why? Mainly because tax planning is a separate engagement, requiring additional information, time and various aspects of knowledge other than tax filing

How does a tax preparer get paid?

Tax preparers are paid in a couple of different ways, depending on the client, type of taxes, and the tax preparer. Some tax preparers charge a flat fee, with additional flat charges for each additional form over the standard return. Others may charge an hourly rate based on the complexity of the taxes, the work they do, and whether the taxes are personal or corporate. Some tax preparers work as independent contractors and set their own rates, while others work for tax preparation companies or agencies and are regular employees. They can also work directly for the companies for which they are doing taxes.

 

Hiring a Paid Preparer

Most tax return preparers provide outstanding service. The IRS urges taxpayers to check their tax return preparer’s qualifications and history. Taxpayers should ask about service fees before they give their records to a preparer.

Taxpayers should not use a preparer who will e-file a return using only a pay stub instead of a Form W-2. Taxpayers should review the return and ask questions before signing. A taxpayer is responsible for the information on the tax return, no matter who prepared it.

Types of Paid Preparers

Different types of preparers have differing skills, education and expertise. Another important difference is a preparer’s ability to represent taxpayers before the Internal Revenue Service.

There are two types of representation rights, also known as practice rights: unlimited and limited representation.

Preparers with unlimited representation rights can represent clients on any matters. That includes audits, payment issues, collection issues and appeals. Those with limited representation rights can only represent clients whose returns they prepared and signed. They can only represent a taxpayer when dealing with revenue agents, customer service representatives, and similar IRS employees, including the Taxpayer Advocate Service.

Credentialed Return Preparers

Tax return preparers with unlimited representation rights include these professionals:

• Attorneys are licensed by state courts, the District of Columbia or their designees, such as the state bar. They have a law degree and passed a bar exam. Attorneys generally have continuing education and professional character standards. Attorneys may offer a range of services. Some attorneys specialize in tax preparation and planning.
• Certified Public Accountants. CPAs are licensed by state boards of accountancy, the District of Columbia, and U.S. territories. CPAs must pass the Uniform CPA Examination. They completed a study in accounting at a college or university and met experience and good character requirements established by their board of accountancy. To maintain an active CPA license, CPAs must comply with ethical and continuing education requirements. CPAs may offer a range of services. Some CPAs specialize in tax preparation and planning.
• Enrolled Agents. The IRS licenses enrolled agents. They’re subject to a suitability check and have passed a three-part Special Enrollment Exam. The comprehensive exam covers federal tax planning, representation and tax preparation for individuals and businesses. They must complete 72 hours of continuing education every three years. Learn more about the Enrolled Agent Program.

 

What does a tax preparer do?

Tax preparers are finance professionals who prepare and file individuals’ and businesses’ tax returns. They meet with clients to gather their tax information, such as marital status, number of children and other dependents, salary and other taxable income among other information required by the Internal Revenue Service (IRS). Then they fill out, sign and file all the appropriate forms according to federal and state tax codes. Since tax returns can range from simple to extremely complex, many people and companies hire tax preparers to do their taxes correctly and make sure they get the greatest tax refund for their situation.

Tax preparer responsibilities can include:

• Performing administrative duties, such as answering phone calls and setting up appointments
• Gathering and organizing personal and confidential paperwork on clients’ income, expenses, allowances and more
• Understanding adjustments, credits and deductions, as well as federal and state tax laws
• Doing math equations and double-checking calculations and data entries to make sure they are correct
• Working with financial and accounting software
• Providing clients with future tax planning advice and recommendations
• Processing billing for time spent doing clients’ tax returns

 

Salary for Tax Preparers

Many small businesses and individuals seek help in filing their tax returns. The professionals who prepare and file their taxes are tax preparers. The complexity of tax forms that they prepare ranges from simple to extremely complex, and may include reviewing the work of other tax preparers to ensure accuracy. As professionals, their goal is to ensure that a client pays the minimum tax required and receives the largest tax return possible, where applicable. Individuals in this occupation must stay current regarding tax code changes and available deductions and benefits. Familiarity with tax law, codes and financial software, as well as a high school diploma or its equivalent, are requirements for this occupation.

A Tax Preparer will usually earn wages on a scale from 24000 to 36000 based on levels of tenure. Tax Preparers will most likely earn a compensation of Thirty Seven Thousand One Hundred dollars every year.

Tax Preparers can make the most money in Massachusetts, which has average pay levels of approximating $60440. Professionals that work in these jobs are compensated highest in Finance and Insurance, where they can get salary pay of $48940.

 

What is the Pay by Experience Level for Tax Preparers?

An entry-level Tax Preparer with less than 1 year experience can expect to earn an average total compensation (includes tips, bonus, and overtime pay) of $11.19 based on 155 salaries. An early career Tax Preparer with 1-4 years of experience earns an average total compensation of $12.21 based on 624 salaries. A mid-career Tax Preparer with 5-9 years of experience earns an average total compensation of $14.51 based on 286 salaries. An experienced Tax Preparer with 10-19 years of experience earns an average total compensation of $15.47 based on 267 salaries. In their late career (20 years and higher), employees earn an average total compensation of $20.

Tips for Choosing a Tax Preparer

Verify the Preparer’s Credentials

There are a lot of people out there claiming to be a “tax professional.” However, just because someone hangs out a shingle and advertises tax prep services, it doesn’t mean they actually have the skill, education, and expertise to handle your return.

Check the Preparer’s Professional Record

You have to be able to trust your tax preparer. Afterall, he or she will know all about your finances and even have your Social Security number. And even if a preparer is credentialed, that doesn’t guarantee that he or she has a good professional reputation. That’s why it’s smart to check a preparer’s history before handing over your tax and financial documents.

Ask About Fees

As with any other service or product you buy, make sure you have a good idea of the costs ahead of time. Prices for tax return preparation can vary widely depending on a variety of factors, including the complexity of your return, where you live, and the preparer’s experience. That’s why it’s important to get a quote before settling on a preparer.

Watch for Problems After Selecting a Preparer

Your due diligence doesn’t end after you pick a preparer. Watch out for warnings signs that something isn’t quite right. If one of these red flags pop up, you should seriously consider switching to another preparer right away.

Report Problems to the IRS

If you do run into a dishonest tax preparer, you can report them to the IRS using Form 14157. If you suspect that a preparer filed or changed your return without your consent, file Form 14157-A.

 

How to Find a Tax Accountant

Review Their Qualifications

Wondering how to find a good tax accountant? Before you hand over your money to a tax advisor you should take a close look at the tax accountant’s qualifications. New IRS regulations require anyone who’s paid to prepare tax returns to have a Preparer Tax Identification Number or PTIN. You should steer clear of any tax preparer who doesn’t have this credential or refuses to disclose it to you.

Look Into Their History

Just because someone is professionally qualified to prepare your tax return doesn’t automatically make them the best person for the job. If they’ve got a questionable history, that’s something you want to know about up front.

Check Their Availability

Once tax season gets underway you’ll start to see tax prep providers pop up everywhere. While some of them may be affiliated with established companies that provide year-round services, others close up shop as soon as tax season ends. That can be a problem if you need to amend your return later on or you have tax questions.

 

How to Choose the Right Tax Preparer

Find out how the tax preparer handles auditsHopefully this will not be an issue in the future but it is better to be safe than sorry. Will the tax preparer answer questions from the IRS for you? How will the fee be calculated to do this or to fix any mistakes?

Will the tax preparer be available for questions after tax season? Some tax preparers are seasonal, which is not very helpful when you receive notices mid-year from the IRS for more information.

Find out when you will receive a copy of your tax return. It may not be immediately, but it should be within a reasonable amount of time.

Know exactly who will be preparing your return at a firm. Will you need to sign the return or will the tax preparer do so? Beware of a preparer who refuses to sign a tax return.

Make sure they can file returns electronically. In this day and age, this is a must.Refunds are faster and there are less errors.

 

Tips to Find a Good Tax Preparer

Favor a Tax Preparer With a Long View

Tax season officially ends April 15, but a good tax preparer will help plan for tax savings for this year, next year, and beyond, says Joseph Conroy, a certified financial planner at Synergy Financial Group in Towson, Md.

Ask for a Price Quote

Often, a tax preparer will say that he can’t tell you what he’ll charge until he determines which forms you’ll need. But you can try to pin down an answer by presenting the forms you completed last year or by asking for a list of fees for various types of tax help, Morris says.

Find a Preparer With Clients Like You

Ideally, you want a preparer with clients who are similar to you. That way, you’re more likely to get the best service for your particular needs.

Look for a Well-Established Pro

Ideally, it’s a good idea to find a preparer who has had at least seven to 10 years of experience, says Daniel Morris, a CPA and senior partner at Morris + D’Angelo, a CPA firm headquartered in Los Angeles. The reason: The more time a preparer has been working on tax returns, the more likely he is to have dealt with a tax situation similar to yours.

Check the Tax Preparer’s Credentials

Anyone with a preparer tax identification number can handle and file your taxes, but it’s best to find someone who also can handle audits, IRS collections, and appeals, says Ann-Marie Long, a CPA and tax manager at SKC & Co., a CPA firm based in Boonton Township, N.J. Only a certified public accountant or an enrolled agent—another type of tax professional—can represent you before the IRS in those situations, she notes.

 

Tips for Choosing a Tax Preparer This Year

Ask about availability

Tax preparers tend to be pretty busy during tax season. Throw in the fact that many are still getting used to last year’s tax changes, and you might be hard-pressed to find someone who can hammer out your return on a whim. You have until April 15 to file your return this year, so if you find a tax preparer who can work with you, say, during the last week of March, that gives you a decent window to complete your taxes before the deadline.

Find out whether you’ll get audit support

You can be as honest with the IRS as possible and have the most meticulous tax preparer in the world, and sometimes, your return might get flagged for an audit nonetheless. Since that possibility always exists, one thing you should be sure to inquire about is whether the tax preparer you hire will provide audit support in the event you need it. As mentioned earlier, not all tax preparers are authorized to represent clients in IRS matters, so it pays to find someone who is.

Figure out what your fees will entail

Clearly, the drawback of hiring a tax preparer is having to pay for that service, but if you do your research, you might keep that cost manageable. The amount you’re charged will generally depend on how complicated your tax situation is and how many unique tax forms the professional you hire will need to prepare.

Check for the right qualifications

Tax preparers have varying levels of training and skills, so if you’re going to hire one, you might as well get your money’s worth. While a non-CPA accountant might technically be qualified to prepare your return, it often pays to hire an actual CPA or an enrolled agent (a federally licensed tax practitioner). Both CPAs and enrolled agents are authorized to represent clients in IRS matters, so if the need arises, that’s some nice protection to have.