You Could Be Paying Less in Taxes With These 7 Strategies
They say it because it’s true: The only certain things in life are death and taxes.
While we’re still working on the whole immortality thing, we have found some ways to reduce that pesky bill from Uncle Sam each April.
Don’t worry, we’re not talking about tax evasion. Throwing some bones to the government is a way better alternative than going to jail. (And besides, who doesn’t like roads and public libraries?)
But there are some totally aboveboard ways to keep more of your hard-earned dollars in your pocket.
Here are some ways to save money on taxes that won’t get you in trouble with Uncle Sam.
1. Reduce Your Taxable Income
One surefire way to not pay income tax: don’t earn any income!
Of course, for most of us, that plan won’t work. Unless you’re independently wealthy (or Bear Grylls-ing it in the woods somewhere), you need money to live on.
But there are ways to reduce your taxable income while still earning a living — and doing them might put you in a lower tax bracket. (To review: the amount you pay in income tax depends on how much of that income you earn, with higher earners being required, sensibly, to pay a higher percentage.)
The easiest way to reduce your taxable income — without throwing in the towel at work, of course — is to contribute to a tax-deferred retirement savings vehicle, like your company’s 401(k) plan.
Wages you defer to a 401(k) don’t count toward your taxable income for the year you make the contribution, though they will be taxed when you make withdrawals later.
Depending on how much you earn and how much you put away, you might be able to edge yourself down into a lower tax bracket… all while feeding your growing nest egg and setting yourself up for a comfortable retirement. Smart finances all around!
Which leads us to our second suggestion…
2. Contribute to a Traditional IRA
Even if you already have a retirement savings account at work, like a 401(k) or a 457(b), you can still open and contribute to a traditional IRA (Individual Retirement Account) — you just need to have earned taxable income and not yet have reached age 70 ½.
What Is a Traditional IRA?
Just like that company-sponsored retirement plan we were talking about, the funds you contribute to your IRA don’t count toward your taxable income.
The exception: a Roth IRA, in which contributions are taxed today but then grow tax-free thereafter.
How Much Can You Contribute?
For 2018, you can contribute up to $5,500 to an IRA, or $6,500 if you’re over the age of 50. (Looking ahead to the future? 2019’s contribution caps have been raised to $6,000 and $7,000, respectively.)
Keep in mind that you have until tax day to max out your contribution for the previous calendar year.
An important caveat: If you’re a relatively high roller (i.e., you earn more than $100,000), you may not be able to deduct your full IRA contribution or any contribution at all.
Your specific eligibility will depend on whether you’re filing singly or jointly and whether or not you’re covered by a retirement plan at work; head to the IRS website for full details on these phase-out limits.
3. Consider a Health Savings Account
While IRAs are widely available and applicable to almost everyone, quite a few other investment accounts can get you this same kind of tax break.
What Is a Health Savings Account?
A Health Savings Account (HSA), is a tax-exempt option if your healthcare plan has a high deductible. Not only are your contributions deductible, but withdrawals aren’t taxed, either, as long as they’re used for qualified medical expenses.
How Much Can You Contribute?
In 2019, you can contribute up to $3,500 to an HSA if you have individual coverage, and up to $7,000 if your high-deductible health care plan (HDHP) covers a family.
And you don’t have to spend it all, either — you can leave funds in your HSA indefinitely since they’re not subject to required minimum distributions. (And if you’re like most of us, you’ll have more health care-related costs as you get older, anyway.)
However, do keep in mind that if you receive Medicare coverage, you might not be eligible to make HSA contributions, since you’ll have coverage outside of your HDHP.
4. Put Your Kids Through College
If you’ve got kids, chances are you’re already gritting your teeth just thinking about paying for college — even if you’re not planning on paying for all of it.
According to U.S. News & World Report, average costs range from $9,716 to $35,676 for a single year of education, so it’s important to get ahead of that bill now.
What Is a 529 Plan?
A 529 plan is an investment vehicle specifically built for educational savings. You can use it to pay for your kids’ college tuition — or even to send yourself or your spouse to school. The exact tax benefits vary by state, and the contributions aren’t deductible on your federal return.
But more than 30 states offer full or partial tax deduction or credits on 529 contributions, and the funds are allowed to grow tax-free. They won’t be taxed on withdrawal, either, so long as they’re used for qualified educational expenses.
What Expenses Qualify for the 529 Plan?
What qualifies, you ask? College tuition, fees, books and computers all count, and in some cases, it’ll cover room and board. You can also take out up to $10,000 per year to pay for tuition at private or religious K-12 schools. (That’s $10,000 per beneficiary.)
But if you try to take the money out to pay for red Solo cups, you’ll be subject to regular income tax on the withdrawal, as well as an additional 10% penalty. So keep those noses in the books if you want to keep your own books nice and tidy!
5. Give It Away
Looking for a way to save money on taxes… and get that warm, fuzzy feeling? Charitable donations are tax-deductible, and they can be a great way to lower your overall tax liability.
The easiest way to go about this strategy might be to just write a check to your favorite charity. But if you’re KonMari-ing your life, you can also itemize those trash-bagged Goodwill donations as deductions. (Of course, you will need to say “yes” when the attendant asks if you want a receipt, should you want to do so.)
But Keep the Books
Of course, doing so does mean keeping track of the estimated value of each of those old t-shirts and coffee makers. But lots of tax software includes tools to help you.
For instance, TurboTax’s ItsDeductible module will keep a running tally of your donations year-round, and help you make those value estimations in the first place.
The cans you drop off at the local food bank count, too, as do certain out-of-pocket expenses incurred by volunteering, such as gas and mileage.
You’ll save money while serving your community — what more could you ask of a tax-reduction strategy?
6. Know Your Deductions
You may already know that certain expenses are tax-deductible. But which ones, exactly?
Major medical bills: If you’ve spent more than 7.5% of your AGI (adjusted gross income) on qualified medical expenses, you may be able to write them off.
Student loan debt interest: Deductible up to $2,500
Mortgage interest and local property taxes: These may both be eligible for partial deductions — and if you’re a first-time buyer, you may be able to make penalty-free withdrawals from that IRA we were talking about earlier.
Charitable donations: These have a tax-deductible status, as mentioned above.
Business-related deductions: If you’re a freelancer or you work from home, you should also look into business-related deductions, like the cost of your home office space.
You might also be able to deduct certain supplies, travel expenses, and even meals and entertainment. Here are the full deets on freelancing deductions.
Itemizing your deductions does take time, however, and not everyone has enough to supersede the standard deduction — which is a fairly hefty $12,000 for single filers and $24,000 for joint filers in 2018.
So if you haven’t footed any of the expenses we mentioned, consider skipping this strategy.
7. Take Advantage of Tax Credits
In certain scenarios, the IRS extends credits to eligible taxpayers — for instance, those pursuing continued education or returning to school.
American Opportunity or Lifetime Learning Credits: Depending on your enrollment status, AGI, and how you’ve paid for educational expenses, you may be entitled to the American Opportunity or Lifetime Learning Credits, along with tuition and fee deductions. (Check out this quick quiz from the IRS, which will tell you if you’re qualified in just 10 minutes.)
Earned Income Tax Credit: If you’re not quite making fat stacks, you might be eligible for the Earned Income Tax Credit, a benefit the IRS extends to low-to-moderate earners.
Your credit depends on your exact level of income as well as your marital status and number of dependents. For details, check out the IRS’ Earned Income Tax Credit fact sheet.
The cool thing about tax credits is that they don’t just reduce the amount you’ll pay in income taxes. Rather, they count as an actual reduction of your total tax bill.
So, for instance, if you would have owed $500 and claim $1,000 in tax credits, not only will your payment be waived — you’ll also receive a $500 return.
3 Ways to Save Money on Taxes Today and Tomorrow
While the strategies above are great ways to get ahead of a nasty tax bill this year, taking a proactive approach can help you pay less in taxes every year hereafter. Here are our suggestions.
1. Adjust Your Withholdings.
If you work for an employer, you’ve filed a W-4 — which is the document where you specify how much of your wages should be withheld for taxes.
It might seem intuitive to keep your withholdings as low as possible so you keep more of your paycheck in your pocket. But if you found you owed money in April, you might want to go in and tweak it so you don’t run into the same problem next year.
2. Automate Your Contributions to Those Tax-Deferred Accounts.
Chances are your employer automatically deposits your deferrals into your 401(k). But if you open an IRA, HSA or 529, you’ll have to make contributions manually… and it’s all too easy to forget to do so (or, let’s be honest, spend the money on something else.)
Most account providers will allow you to set up automatic contributions on a regular basis, be it weekly, bi-weekly, or monthly. That way, you’ll be sure to add enough funds to the account to significantly lower your tax bill while boosting the savings you’ll use for those qualified expenses down the line.
3. Work for Yourself? Don’t Forget to Pay Your Quarterlies!
Freelancers get a lot of autonomy, but it does come with a substantial drawback: Nobody’s withholding your taxes for you, so you’ve got to pay them yourself.
And if you don’t keep up with your estimated quarterly tax payments — or if you forget about self-employment tax, which adds an additional 15% to the usual 20% — you could be facing a downright scary situation come April.
So funnel about a third of every paycheck you make into a separate account, and label it “PROPERTY OF UNCLE SAM: DO NOT TOUCH.”
It can be painful to see how much of your hard-earned hustle money has to be shipped off to the government… but not nearly as painful as having to cut a five-figure check come springtime.
Jamie Cattanach’s work has been featured at Fodor’s, Yahoo, SELF, The Huffington Post, The Motley Fool, Roads & Kingdoms and other outlets. Learn more at www.jamiecattanach.com.