You might think that taxes are a necessary evil better left for professionals, but understanding the basics can help you minimize the total amount of taxes that you pay.
When planning for taxes, we usually think of the Federal filing deadline of April 15, however, you are required to pay taxes throughout the year. Paying the right amounts throughout the year will save you from having to pay penalty charges for underpayments.
For most of us, the payments we make throughout the year are made on our behalf through our employers. Employers automatically withhold taxes from our gross earnings before giving us our net earnings, the little numbers on our paychecks (or big numbers for you lucky ones). Your employer is also responsible for reporting your total income and taxes paid by submitting form W-2 to the IRS. You must then file your taxes; which tells you the total amount of taxes owed and the total amount of taxes already paid-and either pay the difference (if your automatic deductions were too small) or collect the difference (if your automatic deductions were too big).
Throughout the year, there are important tips to follow in order to prepare for your taxes.
- First of all, get organized. Experts recommend the use of personal finance software to enter and maintain accurate records. Keep records of expenses such as automobile mileage incurred for business purposes and get receipts for charitable contributions. It is also very important that you maintain accurate records of the purchasing and selling of stock as well as stock options.
- You may have heard before that you should contribute the maximum to your 401(k) retirement plan. Doing so will let you defer the taxes you pay on your contributions and will allow your contributions to increase through compound interest.
- Adjust your withholding if your marital status changes or if you are in a different tax bracket than the previous year. If sufficient taxes are not withheld from your paychecks, or if you are self-employed, make estimated tax payments to the appropriate tax authority to avoid year-end penalties.
- Make contributions to your IRA as early as possible in the year due to the benefits of compound interest .
- Also, consider tax-efficient investments such as tax-free municipal bonds or tax-efficient mutual funds .