A personal CPA Houston can help you plan for taxes by keeping you in compliance and consulting you in how to reduce taxes over your lifetime. Being in compliance means following the tax law and filing required reports by their statutory deadline and tax planning means applying the tax law in a way that helps mitigates tax exposure. When both of these happen, you can avoid penalties and over-paying in taxes. This post will provide some examples of tax strategies to obtain an understanding of how a personal CPA can consult you based on my experience as CPA. Furthermore, I’ll mention some specific examples of how a CPA can keep you in compliance.
The Landscape of Tax Strategy From a Personal CPA in Houston
We can categorize tax planning into three primary buckets. Those buckets include changing the character of income (ordinary; capital; business income), changing the timing of income and deductions, and optimizing available tax credits and deductions. Whether it be determining the best organizational structure for a business or estate planning, you can be assured that the planning tools being assessed will fall into one of the three categories mentioned above. Consider the following examples to illustrate this point.
Example 1: Real Estate Investment Consider an individual who invests in real estate. By holding onto a property for more than a year before selling, the income from the sale is treated as long-term capital gains rather than ordinary income. This is an example of changing the character of income, as capital gains often have a lower tax rate than ordinary income. Additionally, the investor can strategically time the sale of the property to a year when they expect a lower overall income, thereby changing the timing of income to potentially fall into a lower tax bracket.
Example 2: Charitable Contributions Another common tax strategy involves charitable contributions. An individual might decide to “bunch” several years’ worth of charitable donations into a single year, allowing them to itemize their deductions and surpass the standard deduction amount. This is an example of changing the timing of deductions. Furthermore, by donating appreciated stocks or assets, the individual can also avoid capital gains tax on the appreciation, optimizing available tax credits and deductions.
Example 3: Starting a Home-Based Business
Imagine an individual, Sarah, who starts a home-based graphic design business. By doing so, she can change the character of her income. Instead of just earning a salary (ordinary income) from her day job, she now also earns business income. This allows her to deduct business expenses such as a portion of her home’s utilities, office supplies, and even a part of her rent or mortgage as a home office deduction.
Furthermore, Sarah can decide when to bill her clients or when to make significant business-related purchases, thereby changing the timing of her income and deductions. For instance, if she anticipates a higher income next year, she might delay billing some clients until the beginning of that year.
These examples illustrate the categories of tax strategy. Now that you have a better understanding of the tax planning landscape, I will discuss some high leverage areas of concern when it comes to this topic – areas that yield the most significant value and impact.
Personal CPA Houston: Maximizing Deductions For Individuals
For an individual with no business, the first step in maximizing deductions is to obtain an understanding of what you are spending. Then once you obtain an understanding of how much you are spending to consider whether there are any tax benefits for those types of expenses. Here are three types of deductions that the tax code favors:
Medical Expenses: You can deduct medical expenses that exceed 7.5% of your adjusted gross income (AGI). This includes a range of costs, from doctor’s visits and surgeries to prescription medications. If you have significant medical expenses planned, such as an elective surgery, consider timing it in a year when you’re bunching deductions.
Charitable Contributions: Donating to charity is tax deductible. Keep detailed records of all charitable donations, whether they’re cash contributions, donated goods, or even mileage driven for charitable purposes.
Retirement Savings: Allocating funds to retirement vehicles such as 401(k)s and IRAs serves a twofold purpose. On one hand, it’s a step towards ensuring a stable financial horizon post-retirement. On the other, these contributions are generally made before taxes, effectively lowering your annual taxable income. As of 2023, the contribution limits stand at $19,500 for 401(k)s and $6,000 for traditional IRAs, with an extra provision of $1,000 for individuals aged 50 and above. Additionally, for those enrolled in high-deductible health schemes, Health Savings Accounts (HSAs) present an opportunity for contributions made pre-tax, coupled with the advantage of tax-exempt growth.
The Bunching Strategy: An advanced approach to deductions is the bunching strategy. This involves accumulating or “bunching” deductions in a specific year to exceed the standard deduction threshold, allowing you to itemize that year and then take the standard deduction in the subsequent year. For instance, if you’re on the brink of the itemized deduction limit, you might choose to make two years’ worth of charitable contributions in one year, pushing you well above the standard deduction. Similarly, if you’re planning a significant medical procedure, timing it in the same year as your increased charitable donations can further amplify your itemized deductions. This strategic bunching can lead to substantial tax savings over a two-year period.
Personal CPA Houston: Maximizing Tax Credits For Individuals
Unlike deductions, which reduce the amount of income subject to tax, credits directly reduce the amount of tax you owe, dollar for dollar. For individuals without a business, there are still numerous tax credits available that can significantly reduce tax liability. Here’s is a list of some of the most impactful:
Earned Income Tax Credit (EITC): This is designed for low- to moderate-income earners. The amount of the credit varies based on income, filing status, and the number of dependent children. It’s refundable, meaning if the credit exceeds the amount of tax owed, you can receive the excess as a refund.
Child Tax Credit: For parents or guardians of children under 17, this credit can provide significant relief. The amount is subject to income limitations and can be partially refundable under certain conditions.
Child and Dependent Care Credit: If you pay for childcare or care for a dependent adult so you can work or look for work, you might qualify for this credit. It’s based on a percentage of the care expenses you incur.
American Opportunity Credit and Lifetime Learning Credit: These are for individuals pursuing higher education. The American Opportunity Credit is available for the first four years of post-secondary education, while the Lifetime Learning Credit is available for any post-secondary education or courses to acquire or improve job skills.
Retirement Savings Contributions Credit (Saver’s Credit): If you contribute to a retirement account like an IRA or 401(k) and meet income requirements, you might be eligible for this credit. It’s designed to encourage retirement savings among low- and moderate-income individuals.
Premium Tax Credit: For those who purchase health insurance through the Marketplace and meet certain income requirements, this credit can help offset the cost of premiums.
Residential Energy Credits: If you make energy-efficient improvements to your home, such as installing solar panels or energy-efficient windows, you might qualify for this credit.
Elderly and Disabled Credit: For those over 65 or retired on permanent and total disability and meet income requirements, this credit is designed to provide some financial relief.
Adoption Credit: If you’ve incurred expenses related to the adoption of a child, this credit can help offset those costs.