You may not think about it, but taxes are one of your biggest expenses. Although certain taxes you pay, such as payroll taxes, are out of your control, the amount you pay for all these taxes are completely within your control. Some of these strategies require a monetary investment in order to reap the available tax benefit while others just require a change in your approach when it comes to paying taxes. Here are a few things you can do to lower your taxes every year.
- Max out your annual contributions on a pretax basis to your employer’s retirement plan (i.e., 401k, 403b, or 457b). You can reduce your 2015 taxable income by $18,000 or $24,000 if you’re over 50 years of age ($18,000 contribution + $6,000 catch-up provision).
- Deduct your annual IRA contribution. There are certain rules and income limitations that must be met, but this move can reduce your 2015 taxable income by $5,500 or $6,500 if you’re over the age of 50 ($5,500 contribution + $1,000 catch-up provision).
- If you can’t deduct your annual IRA contribution, think about contributing to a Roth IRA. As long as your 2015 annual income is below $116,000 for individuals and $183,000 for couples filing jointly, you can contribute $5,500 or $6,500 if you’re over the age of 50 ($5,500 contribution + $1,000 catch-up provision) for each person. Although the contributions aren’t tax deductible, the entire account, including future earnings, can be withdrawn tax-free based on certain rules.
- If you fall into the 15% or below tax bracket, any long-term capital gains or qualified dividends are 100% exempt from tax. One way to lower your tax bracket is to lower your taxes by doing some of the other items recommended in this post.
- If you’re above the 15% tax bracket, offset any short- and long-term capital gains against losses. If you’re holding onto a stock or mutual fund that is under performing or no longer meets your investment needs/criteria, sell it and offset any gains you have in a single year. Net losses up to $3,000 can be taken each year as a reduction against your taxable income.
- When you sell an asset/investment in a non-retirement account, don’t overpay your taxes by not calculating your tax basis. For example, let’s assume you purchased a stock mutual fund for $1,000. Over the years, the fund distributed $500 in capital gains and dividends that you reinvested back into the fund. Since you’ve already paid taxes on the $500 in distributions, your tax basis would be $1,500. So when you sell the mutual fund for $2,000, your capital gain is $500, not $1,000.
- Bundle your itemized deductions in one year and take the standard deduction the following year. For example, don’t claim $12,700 in itemized deductions when the 2015 standard deduction is $12,600 (married couples filing jointly). Pay your current and next year’s property taxes, as well as any charitable contributions, in the same tax year. This way you can take advantage of a bigger itemized deduction in one year, and the following year when your itemized deductions are lower, take the standard deduction
- If you have a high-deductible health insurance plan, establish a health savings account (HSA). Contributions are tax deductible up to a 2015 maximum of $3,350 for an individual plan or $6,650 for a family plan and are exempt from FICA and most state income taxes. The best part of a HSA is that any money you withdraw for eligible medical expenses is tax-free. Note: Since this money grows tax-free, don’t tap it for every nickel and dime of current year expenses as this account will be invaluable to you when you’re retired as you’ll have an asset that can be earmarked for out-of-pocket expenses like Medicare and supplemental insurance premiums as well as long-term care.
- If you don’t have a high-deductible insurance plan, establish a flexible savings account (FSA) with your employer so you can use pretax dollars to pay for uncovered medical expenses ($2,500 maximum in 2015). Much like a HSA, contributions made through your employer to FSA are exempt from federal, FICA and most state income taxes. But, unlike a HSA, the money left over in a FSA at the end of the year is lost, so be careful with how much you set aside in these accounts.
- For child care expenses, a FSA can also be established to cover expenses to provide day care for children under the age of 13. If your company doesn’t offer a FSA for child care, you still can claim a child and dependent care tax credit based on your adjustable gross income (AGI) for qualified annual expenses up to $3,000 per child up to a maximum of $6,000 per year. Note: Your AGI can be found by looking at the bottom number on the first page of your most recent 1040 (Federal Income Tax form).
If financially possible, take full advantage of these opportunities to reduce your income tax bill. Most of these strategies are easy to implement and will result in real money that you can use to pay down debt, establish an emergency fund or increase your retirement savings.