If you want to cut your current tax bill without raising Uncle Sam’s eyebrows, there are a few sure-thing strategies you can consider. Most people consider taxes a once-a-year burden best left to a tax specialist. Hope that you don’t owe any taxes, rejoice if you get a refund then forget about them till next year. The implementation of some very simple tax strategies can ensure your tax season is a joyous one. These simple strategies will save you money and are not so complex or outrageous as to invite scrutiny from the IRS or involve many billable hours by a tax specialist. They allow each and every ordinary citizen to participate in strategies minimizing the government’s tax bite.
1. Boost retirement savings.
The easiest and most efficient way to reduce your current tax bill is to reduce your taxable income. If you contribute to your employer-provided 401(k) or similar retirement account, that sum is removed from your taxable income. While the funds are not available for withdrawal without penalty until you reach the age of 59½, you reduce your taxable income and thus your current tax bill. Think about it, if you contribute $10,000 this year and you are in the 33% tax bracket, you’d pay about $3,300 less in taxes this year. Those funds are locked away in a retirement account. Hopefully you don’t draw them until you are retired and in a much lower tax bracket, as withdrawals are subject to income taxes.
If your work does not have an employer sponsored retirement account, all is not lost. Opening and contributing to a traditional IRA could have the same benefits. A similar tax saving choice if the deductible standard IRA is not available due to income limits would be the Roth IRA. The issue with the Roth is that you don’t realize the tax savings until retirement. So on the Roth you will not be allowed to reduce your current taxable income by the contributions to the Roth, but when you take the funds out in retirement those funds come out without being taxed. Generally ,this deferred tax savings ultimately saves the tax payer far more than the immediate tax savings a traditional IRA offers.
2. Be aggressive with your flex plan.
A lot of employers are offering “flex” plans. These are plans that allow the employee to fund certain expenses on a pretax basis. Similar to how certain retirement savings plan reduce your taxable income, the flex plan can offer the same benefit. The two most common elements of a flex plan are a medical reimbursement and child care expense plan. The medical reimbursement allows for the contribution of up to $2,600. These contributions can be spent on medical procedures, co-pays and medications. The funds contributed to the medical reimbursement are removed from your income and are disbursed tax free if used for qualified medical costs. You can contribute to the flex plan to pay for child care costs with pretax funds as well – up to $3,000 for the care of one person and $6,000 for two or more. Again similar to the retirement plan contributions, contributing to a child care expense flex plan allows funds to escape taxes if used according to flex plan rules and regulations.
3. Save for college in a tax-efficient way.
If you are inclined to fund some or all of the cost of a child’s college education, using tax-efficient strategies can save a lot of money. Saving for college can easily cause a family to go broke. Using tax-advantaged vehicles and strategies can reduce the amount you ultimately need to contribute as well as shield some of those assets when your child applies for financial aid. The 529 plan is probably the first plan that comes to everyone’s minds. It is a very good option. The funds contributed do not receive a tax savings in the year they are contributed to the account, unless yours is one of the minority of states that allows a tax deduction for this contribution. Then, when the child is in college, the funds are withdrawn free of taxes if used for approved college expenses. The 529 plan is included as an asset when the financial aid calculation is made, but it is considered at a much reduced rate in comparison with other assets. Another way to save for college that is less known is through a Roth IRA. The Roth allows for withdrawals up to the amount that you contributed tax-free, no matter what your age however these withdrawals must be timed so as not to be included in aggregate account balances when computing financial aid. A parent could save and invest through a Roth IRA keeping track of the amount contributed over the years. When the child enters college the parent could withdraw funds up to the amount contributed to be used for the child’s education. Unlike the 529 plan, the Roth IRA is not included in federal financial aid calculations, ensuring that the student would receive the maximum amount of financial aid.
4. Bundle your deductions and credits.
A significant hurdle to be able to deduct certain expenses is limits the IRS puts on the specific costs or the standard deduction. So, for example, in order to deduct medical expenses, you have to have medical expenses more than your insurance covers. In addition, those expenses have to exceed 10% of the person’s adjusted gross income (AGI) before they can be counted. Then the amount that is deduced has to be worth more than the standard deduction ($6,350 for singles and $12,700 for married couples) before it makes sense to itemize and get the larger tax savings. So strategies to increase a large amount of deductions in a particular year to overcome this limitation would fall into this category. You can often see this most easily in deductions for donations. Bundling a lot of donations in a year with, say, a lot of unreimbursed medical expenses and deductible mortgage expenses could result in a much higher itemized deduction than the standard deduction provides. If you had spread these expenses out over several years you might not have been able to meet the minimum amounts to make the deduction work.
5. Think about harvesting your investment losses.
There are several strategies within the investment realm to save on taxes. The particulars for these strategies depend a lot on what you are investing in, whether or not you sell the investment and the price that you paid for the investment. The key is to maintain good records to be able to prove any tax strategy you attempt. While the maintenance of good records is required across all tax issues, it is especially important for investment tax strategies.
The first strategy is to mine your taxable portfolio for tax losses. This is known better as “tax loss harvesting.” When rebalancing a portfolio, you will often sell investments that have appreciated, incurring a tax expense. A common technique is to sell investments with losses to offset those tax hits. The investments sold should not be picked solely because of a projected tax loss or gain, but if a decision on the overall value of the investment is made and tax ramifications are considered as a part of that, then the decision could be made while addressing all factors. Be aware of strategies that involve selling an investment at a loss then buying something very similar or the same investment less than 30 days later to recognize the loss and get the tax deduction. You could quickly run afoul of the IRS and have the loss disallowed under what is more commonly known as the “wash sale” rule.
The strategies provided above generally are available to most common American tax payers. There are more specific and nuanced strategies that apply to much more specific situations and are complicated possibly requiring a tax specialist to assist.