It’s true that the years is only half over and you only filed taxes a few months ago. But believe it or not, it’s already time to start planning and preparing for next year’s tax preparations. The biggest mistake that most people make is waiting until the year is over to start their tax preparations. By doing this, you can miss out on many deductions and savings that need to be made well in advance.
In general, you should check over your finances during the middle of each year and make sure that you are on track to optimize your taxes by either minimizing the amount you pay or by maximizing your return. A simple online tax calculator is a great tool. Here are some things you should do to prepare for your taxes before it’s too late.
Pay or Defer Your Property Taxes
Property taxes can be deducted from your itemized deductions on your tax returns. Property taxes can also be paid in full during this year, or deferred until next year. For many of us (that live in high property tax states like Wisconsin), this means that we have to make a decision as to when to pay the property taxes. The goal is to have them offset as much income as possible to help reduce your adjusted income tax rate. In most cases, it makes sense to pay the taxes in the current year so that you can get the full tax benefit in next year’s taxes. However, there are some cases in which the opposite applies. For example, if you are already going to max out your deductions for the year because of some other large, one-time deductions that you have already paid then it might make sense to save this deduction until next year. Also, if you were unemployed or your income was very low in the current year, you may also want to defer this tax benefit until next year. Another example would be if your property taxes are not quite enough to let you itemize your deductions. In this case, you could defer the property tax payment until next year and then pay next year’s in the same year. This would allow you to be able to itemize deductions and save more money on your taxes over the two year period. Whatever your case, it pays to think through how your property taxes will affect your taxes and plan accordingly.
Contribute to Your Retirement Accounts
The money you put into a retirement account throughout the year will also affect next year’s taxes. There are two ways that I can think of off-hand to help manage this better. First, I realize that you can put money into your retirement accounts (like your IRA or Roth IRA) until April 15th of the following year. However, most people that plan to wait until this time will not have the money on hand when it comes time to make a deposit. Thanks to many year end expenses like property taxes and holiday expenses, the beginning of the year is often a difficult time to try to save or invest. Instead, make sure you make contributions throughout the year. Better yet, set your retirement account up at work so that it is taken out automatically.
The other retirment choices you make that affect your taxes are which retirement accounts you put the money into. Most people contribute to a traditional IRA or 401K and the amount of the contributions are not taxed. However, for some (like me) it makes sense to contribute to a Roth 401K or Roth IRA. In my case, my income is rather low when compared to my itemized deductions. That means that even if I would reduce my income by contributing to a traditional 401K or Roth, it wouldn’t reduce my overall taxes at all or by much. My solution is to make contributions to a Roth 401K. I will have to pay taxes on the contributions this year (when my taxes are low) but won’t have to ever pay taxes again on any of the money in that account. It makes sense to look at your retirement accounts throughout the year and make sure you are optimizing them for short term and long term tax savings.
Keep Track of Your Finances and Deductions
Although this tax tip is really obvious, I’m guessing that only a small fraction of the population actually does this. Most people are very disorganized with their finances and it comes back to bite them when they need to file their taxes. By keeping a simple spreadsheet or journal with all of the transactions that can affect your taxes, you can save a lot of time and money when you need to complete next year’s taxes. You’ll save time because you won’t have to spend hours, days or weeks looking for the information you need to complete your taxes. And you’ll save money because you won’t forget about all those tax deductions that aren’t fresh in your memory but that you wrote down instead.
Have any other ways to prepare for next year’s taxes? Leave us a comment.