Yes winter is upon us (at least those of us in the northern states) and that means tax season is right around the corner. While no one enjoys taxes, it is beneficial to have knowledge of it. It is important to know some tax rules in order to take full advantage of it’s deductions.
First of all, you must know how much money you make and what tax bracket you fall into. Most average people, we will fall into two categories. The 15% bracket ($9,276-$37,650) or the 25% bracket ($37,651-$91,150) for 2016. This article will mostly reference these two brackets but the knowledge can be used for any.
Keep track of your taxable income throughout the year. This is mostly income from your job (W2 form), investments (dividends from stocks in a taxable account), etc. You should keep track of this all year but if not, I recommend around October to take a look and start your calculations to find out what bracket you will fall into when the year is over.
Once you know your tax bracket, now is the fun part. Time to play around with your deductions. We want to get our taxable income as low as possible so we get more money back after we file. More money equals more to invest into our main goal of financial freedom.
Let’s look at the view of an individual filing single that makes $46,000 a year.
For our example, this individual is in the 25% tax bracket. Through their work they get a 401k. Any dollar you put into your 401k will decrease your taxable income for that year. This is because it will get taxed as you take it out once you retire. This way we don’t get double taxed. For example sake, this individual puts in $3,000 into their 401k retirement plan. Great, this will decrease his taxable income for the year to $43,000. Still in the 25% bracket but getting a lot closer!
The biggest deduction we get is either the standard deduction or itemized deductions. We can choose one or the other when we file our taxes. For this example we will take the standard. Consult a professional to find out which is right for you. For 2016 and this individual’s standing, the deduction is about $5000. We will keep it easy for math sake. This brings their taxable income down to $38,000. Almost to that next bracket!
Tax season is the perfect time to optimize or further diversify your portfolio. If a portfolio has any stocks that are not performing, maybe their dividend got cut, or price somehow decreased due to market conditions. Now is the time to get rid of it. Usually you purposely sell for a loss to offset a gain. But since we are holding quality dividend stocks for the long run lets say we had one that cut it’s dividend over the course of the year. We sell $500 worth of stocks and reinvest that money into another quality company. The portfolio is optimized, you get rid of a bad investment, and also take a tax deduction in the process. Pretty sweet! You are able to deduct up to $3,000 per year on capital losses or sale of stock.
This brings our total taxable income for the year down to $37,500. Which means we are now in the lower 15% tax bracket! So 10% goes back into our pocket.
If come October your standard deduction combined with 401k contributions is not enough to lower you down. And it is feasible to survive for the next few months and can realistically get into the next bracket, try increasing the 401k contribution percentage each check to make up for the rest.
There you have it. A few helpful tips for you this tax season. Hope you enjoy and can benefit from your newly found tax knowledge. Stay warm this winter!