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Tax time is just around the corner. For some of you, refunds are in the mail. But for others, take note – the IRS is waiting to hear from you! Regardless of where you are financially, we all deal with the same annual tax return known as the IRS form 1040. Interestingly enough many individuals don’t understand what they are reading or how the components combine to tell the Internal Revenue Service their story. Following are some ideas for helping you understand your return.
First and foremost, understand that there is a huge difference between being proactive and reactive in almost all areas. Tax planning is proactive and may be the largest opportunity that many people simply miss. Tax reporting is reactively telling the IRS what happened the year before – your story. How your CPA reports that story is critical. Never underestimate the value of a good tax preparer!
Tax planning must occur before the end of the calendar year. We consider strategies all year long but pay special attention between mid-November and December so that the best choices for taxation and deferral can be selected.
Your tax return is made up of many parts that work like an orchestra. Each line is separate and yet they work in harmony with one another. Similar to a single person in the strings section making a mistake and destroying the beautiful music of the group, one poorly reported number on an individual line of a 1040 can wreck the entire return.
The key lines for most tax payers are line 7, the bottom of page one and line 43. Line 7 is the amount of earned income you have that year. It tells you in large part if you qualify to contribute to various retirement plans and IRAs. It is also the income you have subject to Social Security and Medicare taxation.
The bottom of page one is your adjusted gross income or AGI. This number tells us all of your income that is subject to taxation. Any change you can make in income is referred to above line (above the AGI line) and is more beneficial to you than a below line deduction.
Line 43 tells you the amount of income you have subject to taxation after your itemized or standard deductions and exemptions. Those numbers are key for understanding your marginal (the tax rate you pay on your very last dollar of ordinary income) and effective (what you pay on your average dollar of taxable income) rates. From a planning perspective, those rates or percentages are critical in making the proper decisions. You cannot engage in tax planning without reasonably knowing what those numbers will be.
Keep in mind your taxation resembles a staircase with multiple steps. As each step goes higher the percentage you pay to the IRS increases. Tax planning has many facets but one is to make certain you don’t go any higher than necessary. Obviously there is more. Lots more, but this is a start. Happy tax planning.
Tax advice provided by CPA’s affiliated with Financial Enhancement Group, LLC.
Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.[/vc_column_text][/vc_column][/vc_row][vc_row][vc_column offset=”vc_hidden-lg vc_hidden-md vc_hidden-sm”][vc_widget_sidebar sidebar_id=”sidebar-main”][/vc_column][/vc_row]