18 Ways to Reduce Your Taxes

Spread the love

Death and taxes may be two certainties few people look forward to, but there’s another, rosier certainty — that many ways to shrink your tax bill exist, and most of us can take advantage of at least a few, in order to lop hundreds, if not thousands, off our tax bills each year.

Here’s a look at 18 key ways that you may be able to reduce your taxes. See how many you can act on, now or soon, in order to keep more of your money in your pocket.

Image source: Getty Images.

  1. Get organized.
  2. Claim all the tax deductions you can.
  3. Claim all the tax credits you can.
  4. Donate money, goods or stock to charity.
  5. Contribute to a retirement account.
  6. Use a Flexible Spending Account (FSA).
  7. Use a Health Savings Account (HSA).
  8. Contribute to a 529 plan.
  9. Offset capital gains with capital losses.
  10. Hold on to investments longer.
  11. Time your mutual fund investments.
  12. Buy a home with a mortgage.
  13. Be strategic when selling your home.
  14. Use the right filing status.
  15. Keep up with changes in the tax code.
  16. Employ a tax-friendly Social Security strategy.
  17. Use tax-prep software.
  18. Get help from a tax pro.

1. Get organized.

First up, be organized. Don’t just deal with your taxes once a year, in April. Instead, dedicate a folder or box to tax-related documents, and fill it all year long — with receipts for deductible expenses, 1099 forms and other IRS forms that arrive in the mail, trade confirmations and end-of-year statements from bank and investment accounts that you may need to refer to, and so on. That way, when it’s time to start preparing your tax return — or to hand off needed information to a paid preparer — everything will already be in one place.

Keep your tax-related records for a while, too. It’s smart to keep copies of your returns, at least for a minimum of three years and, to be more conservative, up to seven. You’ll likely be free from any chance of a tax audit by then.

2. Claim all the deductions you can.

As you know, a tax deduction shrinks your tax bill by shrinking your taxable income. If, for example, you earn $70,000 and take a $5,000 deduction, your taxable income will shrink by $5,000, letting you avoid being taxed on that $5,000. If you’re in a 24% tax bracket, that could save you $1,200.

It’s a little more complicated than that, though. You can choose to itemize and claim all your various deductions, or you can just take the “standard deduction” available to all taxpayers. That deduction has been roughly doubled in recent years, making it the smart (and easy!) move for most taxpayers.

Filing Status

Standard Deduction for 2020 Tax Year

Single

$12,400

Head of Household

$18,650

Married Filing Jointly

$24,800

Married Filing Separately

$12,400

Source: Internal Revenue Service.

Here are a few things you need to know about deductions:

  • There are lots of tax deductions out there. You may qualify for more than you think. There are deductions for expenses ranging from charitable contributions to medical expenses to the sale of your home to retirement account contributions and to bad debt, among many others. (The IRS has a more comprehensive list of tax deductions, and this 2019 review of deductions is also rather thorough.)
  • You can take some deductions even if you don’t itemize. Those include deductions for contributions to retirement accounts like an IRA, contributions to Health Savings Accounts (HSAs), alimony from a divorce, student loan interest, and self-employment taxes.
  • Some well-known and commonly used deductions have gone away. The Tax Cuts and Jobs Act of 2017 eliminated some tax deductions, such as the miscellaneous deduction (which included job-search fees and tax-preparation fees), and the deduction for moving expenses (for most people, but not military folks).
  • If you don’t have quite enough deductions to make itemizing worthwhile, you might do well to “bundle” some deductions by moving up some expenses you’d pay next year, paying them late this year. For example, you could make an extra mortgage payment, which would increase your mortgage interest paid this year, and if you donate a lot to charity each year, you might make next year’s contributions at the end of this year. By moving around some flexible expenditures, you may be able to itemize deductions one year and then take the standard deduction the following year, and perhaps keep alternating like that.

3. Claim all the tax credits you can.

It’s important to make the most of not just tax deductions, but also tax credits. Credits, after all, are far more valuable than deductions. Remember how a $5,000 deduction might shrink your tax bill by 24% or $1,200? A $5,000 credit can shrink it by $5,000.

The most powerful tax credits are “refundable” ones, meaning that you get their full value even if they shrink your tax bill to less than zero. For example, imagine that you’re on track to owe $4,000 in taxes but you then apply a $5,000 tax credit. If it’s an ordinary credit, it will wipe out all of the $4,000 you owe, and will stop there. A refundable credit, though, will wipe out the $4,000 and then still give you that last $1,000 of value — via a tax refund.

There are lots of tax credits available, relating to expenses for education, the adoption of a child, dependent care, energy-efficient home improvements, and more.

4. Donate money, goods, or stock to charity.

As mentioned earlier, you can take a tax deduction for donations to qualifying charitable organizations — and that includes donations made in the form of cash, stocks, goods, and even miles driven.

  • The non-profit organization must qualify for charitable status under Section 501(c)(3) of the Internal Revenue Code. That generally rules out political organizations, fraternities, and social and business clubs. (Most GoFundMe contributions also don’t qualify, as they’re technically personal gifts, but those made to a “GoFundMe Certified Charity” do qualify. You can look up whether an organization is tax-exempt at the IRS website, and alternatively, you can ask the organization itself. It may have a “determination letter” stating that it has qualified for tax-exempt status that it can show you.
  • Save your receipts! If you’re donating $250 or more in cash or goods, the IRS requires “a bank record, payroll deduction records or a written acknowledgment from the qualified organization showing the amount of the cash and a description of any property contributed, and whether the organization provided any goods or services in exchange for the gift.” (That’s because if you donated $50 to an organization and got a t-shirt valued at $10 in return, you can only deduct $40.)
  • Non-cash donations totaling more than $500 will require that you fill out and include Form 8283 with your return.
  • When donating goods, know that you can generally only deduct their fair market value, not their value when originally purchased. Large charities such as Goodwill and the Salvation Army have donation value guides online, where you can look up values you can claim. A business suit in good condition may only result in a $12 deduction, for example, while a bicycle may only get you $10. But added together, many items can easily get you hundreds of dollars in deductions.
  • There are special rules governing the donation of cars to charities. For example, the IRS states that, “Charities typically sell the vehicles that are donated to them. If the charity sells the vehicle, generally your deduction is limited to the gross proceeds from the sale.” (Of course, there are exceptions to that rule, too.)

Image source: Getty Images.

5. Contribute to a retirement account.

Tax breaks are available to you if you contribute to retirement accounts such as IRAs and 401(k)s, but it depends on whether you contribute to a “traditional” or “Roth” version of the account. Contributions to Roth accounts give you no upfront deduction, but if you play by the rules, when you withdraw from the account in retirement, that money will be yours tax-free.

With traditional IRAs and 401(k)s, you can generally deduct the amount of your contribution from your taxable income. So if your taxable income is $65,000 and you sock away $5,000, that drops your taxable income to $60,000, letting you avoid taxation on that $5,000. (You do get taxed on it later, when you withdraw it.)

For the 2020 tax year, you can contribute up to $6,000 to an IRA (or a total of up to $6,000 can be divided among multiple accounts), plus an extra $1,000 for those 50 and older. With 401(k) accounts, in 2020 you can sock away up to $19,500, plus $6,500 for those 50 and older.

Note that it’s actually not too late to make a 2019 contribution to your IRA(s) — that deadline is April 15, 2020.

Not only can contributions to retirement accounts give you tax breaks — they can also help you set yourself up for a more comfortable retirement. The table below shows how much you might amass saving various sums annually and earning an average annual gain of 8%:

Growing at 8% for

$5,000 invested annually

$10,000 invested annually

$15,000 invested annually

10 years

$78,227

$156,455

$234,682

15 years

$146,621

$293,243

$439,864

20 years

$247,115

$494,229

$741,344

25 years

$394,772

$789,544

$1.2 million

30 years

$611,729

$1.2 million

$1.8 million

Source: Calculations by author.

6. Use a Flexible Spending Account.

Many employers will let you set up a Flexible Spending Account (FSA), which lets you sock away funds for qualifying healthcare expenses on a pre-tax basis, shrinking your tax bill. For example, you might contribute the maximum (for 2020) of $2,750 to your FSA and then spend it on, say, prescription drugs, braces for your kid, therapist visits, and some doctor visits. That $2,750 will not show up as taxable income, meaning that if you’re in the 24% tax bracket, you’ll avoid paying $660 in taxes on it.

There’s a little catch, though — that’s use-it-or-lose-it money. If you don’t use those funds during the year, they go up in smoke. (Some employers give workers an extra grace period until March 15 in which to spend the money.)

There are also Dependent Care FSAs, which help people pay for dependent-care expenses with pre-tax money, and those have a $5,000 annual contribution limit for most folks.

7. Use a Health Savings Account.

Even better than a Flexible Spending Account is the Health Savings Account (HSA), which also lets you pay for qualifying healthcare expenses with pre-tax money. For starters, it sports a higher contribution limit — for 2020 it’s $3,550 for individuals and $7,100 for families, with those 55 and older able to contribute an additional $1,000. The money in your account can stay and grow over years, too, and if there’s any left once you turn 65, you can spend it on anything, though withdrawals for anything other than qualifying healthcare expenses will count as ordinary income.

You’ll also need to have a qualifying high-deductible health insurance plan, in order to take advantage of HSAs. They’re not ideal for everyone, as you must be able to afford to pay that high deductible if needed, but if you can, and especially if you’re young and healthy, they can make a lot of sense, as their premiums are lower than plans with lower deductibles.

8. Contribute to a 529 plan.

If you have one or more kids heading to college (or who will incur other qualifying educational expenses) in the future, you can shrink your tax bill by making contributions to a 529 plan. A notable feature of these plans is that you can contribute a lot to them. The rules and plans vary by state, but many states allow you to sock away hundreds of thousands of dollars per account. Money in the account can grow on a tax-free basis, before being spent on qualified education expenses. Some states offer their own tax breaks for contributions by residents to their state plan and some states even offer breaks for those saving in another state’s plan. Read up on 529 plans, if you think they may help you.

Image source: Getty Images.

9. Offset capital gains with capital losses.

Here’s a great tax-shrinking tip: You can offset some or all of your taxable capital gains with capital losses. For example, if you sold some stocks for a total gain of $5,000 this year, you’ll capital gains taxes on that sum. But if you also sell some stocks that give you losses totaling $4,000, you can shrink that taxable gain to $1,000. Indeed, if your losses exceed your gains, you can also deduct up to $3,000 from your taxable income, and then even carry any remaining losses into the next year(s).

As usual, though, there are rules regarding this “tax-loss harvesting,” such as that you first have to offset long-term gains with long-term losses and short-term gains with short-term losses — and you shouldn’t buy back any stock until at least 31 days have passed. Read up on the topic if you think you can profit by it.

10. Hold on to investments longer.

This tax-shrinking tip is very easy: Aim for all your investment gains to be long-term ones, meaning that you held the asset for more than a year before selling it. Long-term capital gains tax rates are 0%, 15%, or 20%, with most of us probably facing the 15% one. Short-term capital gains, meanwhile, for assets held a year or less before being sold, are taxed at your ordinary income tax rate, which could top 30%, depending on your income level.

So if you’re about to sell a stock after owning it for 11 months, think about hanging on a bit longer. It’s not always the smart thing to do, but it can often save you some meaningful tax dollars. Overall, it’s good to aim to hang on to healthy and growing companies for many years.

11. Time your mutual fund investments.

There are tax-shrinking tips that apply to mutual funds, too — such as being mindful of when you sell shares of them. Funds generally distribute income to shareholders (from dividends, interest, and/or capital gains) near the end of the year, and when they do so, their shares will fall in value by the amount of the distribution — because that portion of the shares’ value has been distributed to shareholders. That’s fine for those who have owned the shares for a long time, but if you bought just before the distribution, you’ll end up taxed on that distribution which covers the fund’s past year, even though you only owned your shares for a small portion of the year. So ask the fund company when its distribution is happening, and aim to buy shares after that.

12. Buy a home with a mortgage.

When you set out to buy a home, if you’re lucky enough to have enough cash with which to buy all of it, you may still want to buy it with a mortgage. Why? Well, in part because mortgage interest is deductible. There are some rules, though, such as:

  • Recent tax-law changes make interest deductible only if the home loan was for $750,000 or less. (Mortgages from before December of 2018 or earlier are grandfathered, though, and enjoy the older limit of $1 million.)
  • If your interest deduction, along with your other itemized deductions, is less than the now-rather-generous standard deduction, it won’t be worth using.

Buying a home with a mortgage, especially in our low-interest rate environment, can free up funds that can be invested for your retirement.

13. Be strategic when selling your home.

When it’s time to sell your home, know that you may be able to exclude up to $250,000 of your gain on it (up to $500,000 for those married and filing jointly) via the home sale exclusion rule. That can be a big deal! If you bought your home for $300,000 and sell it for $450,000, your gain of $150,000 can be entirely free of taxes — subject to a few rules:

  • The home you sell must be your primary residence.
  • You need to have lived in the home for two of the last five years (some exceptions apply).
  • This exclusion can only be claimed once every two years.

Image source: Getty Images.

14. Use the right filing status.

This may seem like a minor issue, but filing your tax return with the wrong status can be costly. For example, not all single people should be using the “single” status: If you’re a single parent or support a dependent such as a parent, you may be able to claim the “head of household” status, which will confer some bigger tax breaks. (Scroll up, for example, and you’ll see a much bigger standard deduction.) Meanwhile, most couples will do best by filing jointly, but in some situations, separately is more advantageous. Run the numbers to see what will serve you best.

15. Keep up with changes in the tax code.

Our tax code is very complex, and it changes a little or a lot from year to year. In order to keep your taxes to a minimum, either keep up with changes yourself or employ a tax pro who does so, and strategize keeping the latest rules in mind.

16. Employ a tax-friendly Social Security strategy.

Social Security is vital to most retirees, and there are some tax rules regarding it that you should know. For starters, your Social Security benefits may be taxed. The rules are a bit tricky, and your chances of seeing your benefits get taxed are higher if your income features significant non-Social Security sources, such as wages, self-employment income, interest, and dividend income. Depending on that income, up to 50% or up to 85% of your benefits may be taxable. One way to avoid this is to draw more from income sources such as IRAs and 401(k)s earlier in your retirement, especially if you’re working, while delaying starting to collect Social Security. (That will increase your Social Security benefit checks, too.)

17. Use tax-prep software.

This tip can not only save you money, but can reduce headaches and hassles, too. If your tax situation is fairly straightforward — such as if you (and perhaps your spouse) mainly have just salary income, without self-employment income, business income, complicated investments, and so on — you should consider using tax-prep software to get your tax return done. It automates much of the math and will prompt you for information that can help you maximize deductions and credits.

18. Get help from a tax pro.

If your tax life isn’t so straightforward, or if you just want more reassurance that you’re making the best tax decisions throughout the year and shrinking your bill as much as you can, seek the services of a good tax pro. It’s their job to keep up with all the tax law changes and to know effective tax strategies. Ask around for strong recommendations or perhaps look for an “Enrolled Agent,” a tax pro licensed by the IRS, near you. The National Association of Enrolled Agents website can help.

The more you know about taxes, the smaller your tax bill can be. Taxes may not be super exciting, but saving hundreds or thousands of dollars certainly can be.

The $16,728 Social Security bonus most retirees completely overlook

If you’re like most Americans, you’re a few years (or more) behind on your retirement savings. But a handful of little-known “Social Security secrets” could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,728 more… each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we’re all after. Simply click here to discover how to learn more about these strategies.


Spread the love