18 Ways to Reduce Your Taxes
Taxes get a bad rap. Nearly half of Americans would rather clean out their garage than do their taxes, and 16% would prefer to be stuck in an airport overnight than file their tax return, according to a TD Ameritrade survey.
One way to make tax season, Jan. 1 to April 15, more bearable is to shave loads of money off your tax bill by strategizing year-round.
Here are 18 ways to reduce your taxes. Put as many as you can into action and watch the savings roll in during tax season.
- Get organized.
- Claim all the tax deductions you can.
- Claim all the tax credits you can.
- Donate money, goods or stock to charity.
- Contribute to a retirement account.
- Use a Flexible Spending Account (FSA).
- Use a Health Savings Account (HSA).
- Contribute to a 529 plan.
- Offset capital gains with capital losses.
- Hold on to investments longer.
- Time your mutual fund investments.
- Buy a home with a mortgage.
- Be strategic when selling your home.
- Use the right filing status.
- Keep up with changes in the tax code.
- Employ a tax-friendly Social Security strategy.
- Use tax-prep software.
- Get help from a tax pro.
1. Get organized.
Develop and hone your tax strategy throughout the year and not just during tax season, when each of us must prepare and file a tax return with the Internal Revenue Service (IRS), the federal government agency responsible for tax collection. Tax Day falls on or around April 15, depending on weekends and holidays, and is when all annual tax returns are due.
Designate a place to store all your receipts or documents that may come in handy for taxes, including proof of medical expenses, purchases of deductible items, charitable donations, child care and financial transactions. Add any 1099 Forms and other documents you receive from your banks and brokerages and employers reporting income you’ve received. Keep a system in place to save you time and trouble when you’re preparing to file your tax return.
Keep your tax forms and related documents for a period of years, in case the IRS has questions. The IRS sets the rules for taxation and its website is a great resource for taxpayers with questions about how to reduce their taxes.
2. Claim all the deductions you can.
However much money you earn or receive over the course of the year, know that you’re not going to be taxed on all of it. You get to reduce it via one or more deductions, eventually arriving at your “taxable income,” or AGI (adjusted gross income).
Here’s how a deduction works: If your earnings total $75,000 and you can take a $5,000 deduction, your taxable income will fall by $5,000, and you’ll be avoiding being taxed whatever rate you fall under on that $5,000. That can be worth $1,200 in savings to someone being taxed at 24%.
You can opt to take a “standard deduction,” or you can choose to “itemize” deductions — a method of adding up individual deductions for which you qualify. That’s only worth it if your itemized deductions are more than your standard deduction — and for millions of Americans, the standard deduction will be their best option. (For 2019, it’s$12,200 for single filers and $24,400 for those who are married, filing jointly.)
You may be able to reduce your tax bill significantly if you take several deductions. There’s a wide range of possible deductions — related to owning a home or business, being a student or a self-employed worker, medical expenses, state and local taxes paid and qualifying contributions to qualifying retirement accounts such as traditional IRAs or 401(k)s.
Some deductions can be taken without having to itemize, including contributions to retirement accounts like an IRA, contributions to Health Savings Accounts (HSAs), alimony from a divorce, student loan interest, and self-employment taxes. Most other deductions require itemization.
Recent tax-law changes have fully or partially eliminated many familiar deductions so it’s important to keep an eye on yearly tax changes. Some of the deductions no longer available include those for job-related moving expenses, many casualty and theft losses, and tax-preparation expenses, among others.
Meanwhile, if the deductions you can take don’t look like they’ll amount to more than the standard deduction, there are some ways to boost your total deductions. For example, consider making an extra mortgage payment, to boost your mortgage interest paid, and, thereby, your total itemize-able deductions.
You can “bunch” or “bundle” other deductions, too. For instance, you might make some of your planned 2020 charitable contributions in late 2019 instead of in 2020. You might also pay a property tax bill due in January 2020 in December 2019, for it to count this year. You might even try to have a planned surgery earlier to take advantage of deductions for qualified medical expenses. Alternatively, you can push some expenses back — saving them for 2020 instead of 2019, to be able to itemize more deductions than the standard deduction in 2020.
3. Claim all the tax credits you can.
Just as you should try to grab all available tax deductions, take advantage of all tax credits available to you, too.
Remember how a $5,000 deduction lets you avoid being taxed on that sum, saving $1,200 for those facing a 24% tax rate? Well, credits are even more valuable than deductions — because they shrink your taxable income on a dollar-for-dollar basis. A $5,000 tax credit saves you $5,000 in taxes.
Another distinction to appreciate is that of “refundable” tax credits versus “nonrefundable” ones. With an ordinary nonrefundable credit, if your tax due is $2,000 and your credit is for $2,500, it will wipe out your tax bill, saving you $2,000. If it were refundable, though, it would wipe out your tax bill and pay you the difference — the $500 — as a refund.
Tax credits exist for all kinds of things, such as education expenses, energy-efficient home improvements, adopting children, child care, foreign taxes paid, and more. The Child Tax Credit offers $2,000 per qualifying child, while the Earned Income Tax Credit (EITC) can put more than $6,000 back into the coffers of low-income households.
4. Donate money, goods, or stock to charity.
Donating to charities is a win-win proposition, as the charities get much-needed support while you enjoy a tax break from your contribution via a tax deduction. You can donate money, goods, and even stock in a company.
There are rules to follow, though, of course. The non-profit organization must qualify for charitable status under Section 501(c)(3) of the Internal Revenue Code. The kinds of donation-seeking organizations that generally don’t qualify include political organizations, business leagues, social clubs, and fraternal societies. You can look up which charities qualify as tax-exempt at the IRS website — or ask to see an organization’s “determination letter” stating that it has qualified for tax-exempt status. Contributions to most GoFundMe appeals, by the way, are usually not deductible, as they’re considered personal gifts, but donations made to a “GoFundMe Certified Charity” campaign are tax-deductible. Make sure you’re reading the small print before you make a donation you think is tax-deductible.
For cash (or property) donations of $250 or more, you’ll need “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.” (If you donated $100 to a public radio station, and got a mug worth $10 for your contribution, you can only deduct $90.)
It’s not just cash donations that can provide valuable tax deductions — donations of goods can also qualify. A little time spent digging through your basement, attic, garage, and closets can turn up piles of forgotten clothes or unused household items you could donate. You can benefit by donating all kinds of things, such as books, handbags, blankets, laptops, vacuum cleaners, coffee makers, air conditioners, microwaves, rugs, bicycles, and furniture. Even your old car can be donated, though there are special rules for vehicle donations, such as only being able to deduct the amount the charity got for the vehicle when it was sold, which may be less than the fair market value.
Here are some other rules to know:
- Make sure any organization you’re asked to donate to is legitimate, perhaps by looking it up online. Some scammers make up fake charities with names that are similar to but different from familiar ones — such as, for example, United Ways or the Worldwide Wildlife Association.
- You’ll list donations to charity, along with other itemized deductions, on Schedule A of your tax return.
- If your non-cash donations total a value of more than $500, you’ll also need to fill out IRS Form 8283 and include it with your return.
- You can generally only claim a deduction for the fair market value of what you donate, not how much they cost you when you bought them. Organizations such as Goodwill and the Salvation Army have online guides where you can look up acceptable ranges of fair market value for many used goods.
You can even donate stocks to charity and get a deduction for doing so. It’s far better to donate shares of a stock that have soared in value in your portfolio than stocks you’re losing money on, because you’ll also be giving away the gains on which you would otherwise eventually be taxed. Most major charities will be so happy to receive stock from you that they’ll help you through the donation process. Just ask. You can also donate bonds and even cryptocurrencies.
5. Contribute to a retirement account.
Contributing to a retirement account such as a traditional or Roth IRA and/or a 401(k) account can cut your tax bill while also helping you save money for retirement, something most of us need to do in a big way.
With a traditional IRA or 401(k), you contribute pre-tax money, reducing your taxable income for the year, and thereby reducing your taxes, too. (Taxable income of $75,000 and a $5,000 contribution? Your taxable income drops to $70,000 for the year.) The money grows in your account and when you withdraw it in retirement, it’s taxed at your ordinary income tax rate at the time. That’s good for the many people who will have lower incomes in retirement and will therefore be in lower tax brackets.
With a Roth IRA or 401(k), you contribute post-tax money that doesn’t reduce your taxable income at all in the contribution year. (Taxable income of $75,000 and a $5,000 contribution? Your taxable income remains $75,000 for the year.) But: Your money grows in the account and when you withdraw it in retirement — it’s not taxed. At all.
For 2018, the IRA contribution limit is $5,500 — plus $1,000 for those 50 or older. 401(k) accounts enjoy far steeper 2018 contribution limits of $18,500 plus an additional $6,000 for those 50 and older. In 2019, the IRA contribution limit rises to $6,000, plus the $1,000 catch-up allowance for those 50 and up, and 401(k) limits rise to $19,000 (plus $6,000 for those 50 and over). Many 401(k)s have matching funds available from your employer, so be sure to contribute enough to take advantage of the full amount matched by your employer.
The following table shows how much you might amass in these accounts over time. An 8% annual growth rate is somewhat conservative: The stock market has grown by close to 10% annually, on average, over many decades, but your investment period might feature a lower average.
If you amass one of those sums in a traditional IRA or 401(k), your withdrawals in retirement will be taxed as ordinary income to you. If it’s in a Roth IRA or 401(k), your withdrawals will be tax-free.
6. Use a Flexible Spending Account.
Your employer may offer Flexible Savings Accounts (FSAs), referred to as “flex plans.” These are accounts where you can save pre-tax dollars to spend tax-free on healthcare or dependent-care expenses. If you sock away $2,000 in the account and then spend that on, say, your dental plan deductible, an eye exam, hearing-aid batteries, infertility treatments, prescription drugs, over-the-counter drugs (with a doctor’s note), a pregnancy test, counseling sessions, and/or any of a host of other eligible expenses, you’ll be paying with money on which you’re never taxed. Without the FSA in that case, your money might have been taxed at, say, 24%, shrinking the buying power of that initial $2,000 by $480.
Note that you need to use most of your contribution each year — or you’ll lose it forever. In many accounts, any funds not spent by December 31 will disappear, while some employers offer a grace period until March 15. The contribution limit for Health FSAs is $2,650 for the 2018 tax year, and it rises to $2,700 in 2019. 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 medical-expense Flexible Spending Account, in many cases, is the Health Savings Account (HSA). Like an FSA, you fund an HSA with pre-tax money, thereby lowering your tax bill. The money you save in this account can also be used tax-free for qualifying healthcare expenses.
There are some key differences, though, such as the fact that HSA money isn’t use-it-or-lose-it every year. The money in the account can accumulate over many years, and can grow if you invest the fund in the market. Once you turn 65, you can withdraw money from your HSA for any purpose, paying ordinary income tax rates on withdrawals. The HSA contribution limit is $3,450 for individuals and $6,900 for families for 2018. Those numbers rise to $3,500 and $7,000, respectively, in 2019, and in both years, those 55 or older can chip in an additional $1,000 to catch up.
To use an HSA, you must have a qualifying high-deductible health insurance plan. High-deductible health plans have been growing in popularity lately, as they feature appealingly low premiums in exchange for the insured being willing to pay a lot out of pocket if need be. They make particularly good sense for young and/or healthy people.
8. Contribute to a 529 plan.
Making use of a 529 plan can help you save in taxes. This is a tax-advantaged account that helps people save for educational expenses of a particular beneficiary (i.e., a future college student).
You can save and accumulate a lot of money with a 529 plan, because these plans sport generous contribution limits of up to several hundred thousand dollars per beneficiary. Money in these accounts gets to grow tax-free, and distributions taken to pay for qualified education expenses are not taxed, either. On top of that, many states offer additional tax breaks for their residents who contribute to the state 529 plan — and some states even offer tax breaks for money saved in another state’s plan.
You might also consider the Coverdell Education Savings Account, which offers a wider range of investments, but it only accepts up to $2,000 per year in contributions.
9. Offset capital gains with capital losses.
Here’s a powerful tax-savings maneuver that you might use if you’re sitting on some capital gains and some unrealized capital losses. In other words, you may have sold some stocks for a gain on which you’ll be taxed, and you’re also holding some stocks that have delivered losses (so far) instead of gains. Instead of just waiting for those losses to turn around, while you pay taxes on your gains, you can “harvest” the losses and use them to offset gains. You might keep this strategy in mind throughout the year whenever you’re thinking of selling a stock, or just consider selling some losers in December, before the year is over, so that they can count. It’s not smart to just sell stocks for tax reasons, but it is good to consider tax issues when thinking about selling.
Imagine, for example, that you have $8,000 in gains and you sell enough holdings to generate a loss of $3,000. Do that and you can pay taxes on only $5,000 in gains. If you have way more losses than gains, you can wipe out your gains entirely, then shrink your taxable income with up to $3,000 of your losses, and then carry over any leftover losses into the next year. Capital gains and losses are accounted for on Schedule D of your tax return, where you can also list any losses you’re carrying forward to the next year.
Here’s an important detail, though: If you plan to buy back any of the losers you sold, be sure to wait at least 31 days. Per the IRS, if you buy it back before that, you’ll have what’s called a “wash sale,” and you can’t use the loss to offset gains.
10. Hold on to investments longer.
Time is money. Imagine you’ve held a stock for 11 months and you plan to sell it, realizing a $10,000 gain. Assets that you’ve held for a year or less are considered short-term, and short-term capital gains are taxed at your ordinary income tax rate, which could approach 40%. If you’re only in the 24% bracket, you’ll still face a $2,400 tax. But if you can hang on until you’ve held the stock for more than a year, it will be a long-term holding in the eyes of the IRS, and you’ll face a capital gain tax rate of 15% or 20%, depending on your income level. Most folks would get the 15% tax rate, which would amount to $1,500 for the $10,000 gain. By hanging in there a little longer, you may be able to save $900 or more.
Of course, hanging on is not always best, especially if the company is facing challenges, as its stock might fall in value. Never make investment decisions solely based on taxes, but do factor your holding period into your thinking. And remember that a great way to build wealth is to buy stock in healthy and growing companies, aiming to hang on through thick and thin for years, if not decades, as long as they remain healthy and growing.
11. Time your mutual fund investments.
Mutual funds are popular investments because they’re easy ways to immediately be invested in a lot of stocks and/or bonds, with financial professionals deciding what to buy and sell, and when. You may well have some money in mutual funds, perhaps in a retirement account.
There are particularly good and bad times to buy or sell shares of mutual funds. Think twice before investing in a mutual fund near the end of the year. Why? Funds that distribute dividends (cash payments) to shareholders typically do so in December, and when they do, fund 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 if you’re a longtime shareholder, but if you bought just before the distribution, you’ll be hit with a tax bill for an investment you’ve held for very little time. To avoid the tax and get a lower price, just ask the fund company when the distribution is happening and buy after that.
12. Buy a home with a mortgage.
For many people, buying a home is part of the great American dream, and it usually involves getting a mortgage — a loan from a bank for buying property. Having a mortgage means having to make significant monthly mortgage payments and paying a lot of interest along the way, but there’s a silver lining: The mortgage interest you pay is deductible!
Most people can deduct most or all of the interest they pay on their mortgage each year, which can add up to be a lot of money. What you need to know about the mortgage interest deduction:
- You will have to itemize your deductions to claim it.
- Recent tax-law changes roughly doubled standard deductions, so itemizing deductions will not be worth it for many people, though it may still be worthwhile for you. (For single filers, for example, the 2018 standard deduction is $12,000, and for those married and filing jointly, $24,000.)
- Recent changes in tax law reduced the maximum home loan size for which you can deduct interest from $1 million to $750,000, which only applies to new mortgages.
- The new law limits the deductibility of interest on home equity loans, too. You can now only deduct the interest if the loan was used to buy, build, or improve your home, and if it doesn’t push your total outstanding mortgage debt above the $750,000 limit.
- Total state and local tax deductions are now capped, at $10,000. This limits the deductions available for property taxes for some people.
13. Be strategic when selling your home.
When it’s time to sell your home, you can save a lot of tax dollars by being aware of the valuable home sale exclusion rule. It says that if you follow the rules, up to $250,000 of gain on the sale of your home will not be subject to taxation — and up to $500,000 for married couples who file taxes jointly.
So if you bought a home for $400,000 and sell it for $600,000, you’d have a $200,000 gain, tax free! If you faced a 15% tax on that, you’d be forking over a whopping $30,000. So if you can exclude that gain, you save $30,000!
Read up on the rules before you sell your home, to see if you can take advantage of this money-saving opportunity:
- It must be your primary residence that you sell.
- You should have lived there for two of the last five years (some exceptions).
- You can only claim this exclusion every two years.
14. Use the right filing status.
Don’t assume because you’re unmarried that you should file your tax return using the “single” filing status. If you’re a single parent or support a dependent like an older parent, you may qualify for the “head of household” status, which offers more favorable tax rates and a significantly higher standard deduction. (For the 2018 tax year, for example, the standard deduction for singles and married folks filing separately is $12,000, but it’s $18,000 for heads of households.) The higher standard deduction means your taxable income gets smaller, meaning a smaller tax bill.
Meanwhile, if you’re married, run the numbers to see whether you’re better off filing jointly or separately. Filing jointly is more likely to result in a bigger refund, but everyone’s situation is different. Filing separately can make sense in various situations, such as if one spouse has high medical expenses that can be included among itemized deductions. (The itemized deductions may not be more than the $24,000 standard deduction for married-filing-jointly folks, but they may easily clear the $12,000 standard deduction hurdle for someone who’s married and filing separately.)
15. Keep up with changes in the tax code.
Tax laws are changed by Congress annually, and in some years, they change a lot. Contribution limits for retirement accounts change every few years or every year, and income limits that dictate who’s eligible for various tax breaks change, too.
Some breaks go away, while new ones are added into the tax code. The latest round of tax changes got rid of the deductibility of moving expenses tied to a new job, along with personal exemptions. Estate tax exemptions were significantly increased, and the marriage penalty was mostly erased. Standard deductions were significantly increased, which will lead many millions of tax-payers to no longer itemize their deductions. Deductions for income, sales, and property taxes were capped at $10,000. Tax brackets for individuals were changed recently, too, and corporate tax rates were meaningfully reduced, meaning businesses will have to pay significantly less back to the government.
You can save tax dollars by knowing what the latest rules are and, therefore, what you may be able to deduct or get a credit for. That can help you strategize effectively all year long. So keep up with tax law changes by not skipping the tax section of the news.
16. Employ a tax-friendly Social Security strategy.
You can keep more of your Social Security dollars if you’re savvy about this retirement income program. The first thing to know is that your benefits may be taxed.
While Social Security benefit payments are generally not taxed, they can be taxed. You’re at risk of being taxed on your Social Security benefits if your income over a year features significant non-Social Security sources, such as wages, self-employment income, interest, dividend income, and so on.
You will never be taxed on more than 85% of your Social Security benefits, and if the benefits make up all or vast majority of your income, you likely won’t be taxed on them at all.
To determine whether you’ll pay taxes on Social Security benefits, calculate your “combined” income, which is your Adjusted Gross Income (AGI) plus non-taxable interest plus half of your Social Security benefits. The following table shows the taxation you can expect:
If you’re working late in life and don’t need to start taking Social Security right away while you work, you might do well to delay starting to collect benefits, so that your checks will be bigger when you get them. Drawing more heavily from IRAs and 401(k)s in early retirement years, especially while you’re still working, can help you wait longer to take Social Security.
17. Use tax-prep software.
You can shrink your tax bill by spending a little money on tax-prep software. (There are some free software options and the IRS offers free online tax filing for lower-earning taxpayers.) Using a software package can help you avoid many math errors and can identify available tax breaks by prompting you with questions.
TurboTax, TaxAct, TaxSlayer.com, FreeTaxUSA, and Quickbooks are examples of well-known tax-prep software. Most offer a range of versions that will cost you, with the more costly versions best suiting those with more complicated tax situations, such as people who claim tax deductions and credits, who are self-employed, who have investment income, and/or who have rental properties. Most also charge extra to prepare your state tax form, though some offer that service free with certain products.
Each software provider typically offers a range of products at escalating prices for increasingly complicated tax needs. Still, it’s easy to spend much less than $100 for a solid software package. The following table offers recent list prices for each software package’s relatively basic non-free version.
18. Get help from a tax pro.
Finally, a terrific and easy way to save money for many taxpayers is to hire a good professional to prepare their return — and to advise them throughout the year on various tax issues as well as tax strategy.
After all, taxes are complicated. The services of a skilled tax pro might cost you several hundred dollars, but he or she may be able to save you much more than that — especially if your tax situation is not very simple. A good tax pro will know far more about the tax code than you do and can suggest effective strategies for you.
But don’t just hire anyone. Ask around for recommendations and consider hiring an “Enrolled Agent,” a tax pro licensed by the IRS who is authorized to represent you before the IRS should you require that. You might find someone through the National Association of Enrolled Agents website.
These are just some of many ways to shrink your tax bill. Putting just a few of them to work may save you a lot of money — possibly tens of thousands of dollars.
Originally published at www.fool.com on January 8, 2019.