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How to Reduce Your Tax Bill Next Year

Now that the 2016 tax season is almost over (unless you filed an extension), now is a good time to do some tax planning. Here are a few things you can do now to ensure that you are not hit with a hefty tax bill at the end of the year.

1. Review your payroll tax withholding. This is done by completing a Form W-4 for Federal tax withholding and DE-4 for California State tax withholding. (Every state has their own tax withholding form). With this form, you indicate how many “allowances” you wish to take. The higher the number of allowances, the Less money is withheld from your paycheck for taxes and vice versa. If you owed taxes this year, there is a good chance are claiming too many allowances.
 
Both the IRS and the state of California have posted the 2017 tax withholding Forms on their website. The forms provide you with a worksheet to help you determine the appropriate number of allowances you should claim. You can view them here:
W-4:   https://www.irs.gov/pub/irs-pdf/fw4.pdf
DE- 4: http://www.edd.ca.gov/pdf_pub_ctr/de4.pdf
 
For accurate results, you will need to also fill out the Deductions and Adjustments Worksheet or Two-Earner Worksheet if you fit these situations.
 
It is a good idea to review your payroll tax withholding at least annually or whenever you experience a major life event like a change in marital status, increase or decrease in dependents, salary increase, or job promotion.

2. Make Estimated Tax Payment if necessary
Believe it or not, Federal and State taxes are based on a “pay as you go” system. In other words, we are required to pay taxes as we earn income. That is why our employers withhold taxes from our paychecks on our behalf and remit them to the IRS and State on a regular basis. If at the end of the year, you do not pay the minimum amount in taxes through either payroll tax withholding or quarterly estimated tax payments, and you owe more than $1,000 at the end of the year, you will be subject to the additional underpayment of tax penalty.
 
The minimum amount of tax payment that the IRS requires is the lower of either 100% of your prior year tax due or 90% of what you expect to owe in taxes this year. To make absolutely certain you are paying the minimum amount in federal taxes, make sure your payroll tax withholding in the current year is at least equal to the amount of Federal taxes you paid last year. If at the end of the year, you have not paid the IRS the minimum required amount in taxes and your tax due is greater than $1,000, you will be required to pay an additional 3% to 4% in interest on the total amount of tax due.
 
If you receive income that is not subject to payroll tax withholding such as self-employed business income, gains on sale of investments, interest income, and dividends you will usually need to make additional estimated tax payments to ensure you are paying enough taxes throughout the year.
 
For information on how to determine if estimated taxes are required and how much you need to pay quarterly, go to:  https://www.irs.gov/pub/irs-pdf/f1040es.pdf

3. Maximize your 401K or 403B Plan Contributions
In addition to automatically saving for retirement, the other great benefit of contributing to your company’s 401K (or 403B) plan is that the contributions reduce your taxable income and therefore reduces your tax liability. In 2017, the maximum amount an employee can contribute to their 401K Plan is $18,000 (or $24,000 if you are Fifty years old and older). While you may be able to contribute the maximum allowable amount, it is to your advantage both from a retirement and a tax perspective to contribute as much as your finances can allow.