Tax season can be a stressful time for many individuals and families, especially when you're hit with a higher-than-expected tax bill.

Whether due to unexpected changes in income, deductions, or credits, tax bill shock can be overwhelming.

1. Tax Bracket: The First Step to Smart Budgeting

Before diving into budget realignment, it's essential to understand how your tax bracket affects your finances. Your tax bracket is determined by your income level, and it directly impacts how much you'll owe to the IRS. Many people overlook the importance of tax brackets and underestimate how their income affects their overall tax liability.

Tax brackets are progressive, meaning that as your income increases, so does your effective tax rate. If you've recently had a pay raise or earned additional income from a side hustle, understanding how these changes impact your bracket can help you plan better.

To avoid tax shock in the future, review your pay stubs or annual income closely to ensure you're not underestimating how much you'll owe at the end of the year. Adjusting your withholding allowances with your employer can also help you manage this.

2. Review and Maximize Deductions and Tax Credits

Tax deductions and credits can drastically reduce your tax bill, but many taxpayers miss out on them by not keeping up with available opportunities. Common deductions include those for mortgage interest, student loan interest, medical expenses, and contributions to retirement accounts. Tax credits, on the other hand, directly reduce the amount of tax you owe.

Consider maximizing retirement contributions, such as to a 401(k) or IRA, as these contributions are often tax-deductible. Additionally, if you qualify, make sure to take advantage of credits like the Earned Income Tax Credit (EITC) or Child Tax Credit, which can reduce your tax bill significantly.

Taxpayers often miss significant opportunities to reduce their tax burden through available deductions and credits.

Michael Peterson, wealth advisor, emphasizes that retirement contributions to 401(k) or IRA accounts remain among the most effective tax-deductible strategies available to most taxpayers. For 2024, the 401(k) contribution limit is $23,000, with an additional $7,500 catch-up contribution for those 50 and older.

3. Create a Tax-Smart Budget: Planning for the Year Ahead

Once you understand your tax obligations and opportunities for deductions, it's time to rework your budget to account for taxes more effectively. Tax planning should be a year-round process, not just something to address when filing taxes. By proactively planning throughout the year, you can avoid surprises in April.

A tax-smart budget ensures that you are setting aside the appropriate percentage of your income for both savings and taxes. Use tax withholding calculators to determine if your withholding is on track and adjust as necessary. Allocating a percentage of your income specifically for taxes each month can prevent the need to scramble for funds when tax bills arrive.

4. Automate Savings for Tax Payments: Consistency is Key

One of the easiest ways to manage your tax payments is to automate them. Setting aside a specific amount each month in a separate savings account dedicated solely to taxes can relieve stress when it's time to pay. Automation ensures that you're consistently putting money away and prevents you from neglecting your tax obligations.

To get started, create a separate account for tax savings, and set up monthly transfers that align with your estimated tax liability. When tax season arrives, you'll have the money ready and won't need to adjust your regular spending habits.

5. Reassess Your Investment Portfolio: Optimize for Tax Efficiency

Investments can have a significant impact on your overall tax burden. The income generated by your investments—whether it's capital gains, interest, or dividends—is subject to taxation. However, there are ways to optimize your investment strategy to minimize taxes while still achieving growth.

Consider focusing on tax-efficient investments, such as municipal bonds (which are often exempt from federal taxes) or long-term capital gains (which are typically taxed at lower rates than short-term gains). Additionally, review your portfolio to ensure you are using tax-advantaged accounts effectively and are making the most of opportunities to reduce your taxable income.

6. Consult with a Tax Professional: Leverage Expert Guidance

Navigating tax laws and implementing strategies to reduce your liability can be complex. That's why consulting a tax professional is essential, especially if your financial situation is more complicated than average. A tax professional can help you identify opportunities for deductions and credits that you might not have considered and can offer strategies to reduce your tax burden.

By working with a tax professional, you can develop a tax strategy tailored to your unique situation. They can also help you file your taxes in a way that minimizes your liability while ensuring compliance with all regulations.

Tax bill shock doesn't have to be an inevitability. By taking proactive steps to understand your tax bracket, maximize deductions and credits, adjust your budget, and automate your savings, you can better prepare yourself for tax season and avoid surprises. With the right financial planning, you can keep your finances secure, minimize your tax burden, and focus on your long-term financial goals.

Consulting with a tax professional, understanding the impact of your investments, and adjusting your approach to budgeting and saving for taxes are all key components of a strategy that will keep your finances in check. With realigning your financial strategies now, you can reduce the impact of taxes on your budget, giving you peace of mind in the months ahead.