THIS POST MAY CONTAIN AFFILIATE LINKS. PLEASE READ MY DISCLOSURE FOR MORE INFO.
“The best way to teach your kids about taxes is by eating 30% of their ice cream.”
-Actor/comedian Bill Murray
I read this quote recently, and it made me chuckle. While comical, it’s really a perfect comparison, especially if you enjoy your hard-earned money like I enjoy Ben & Jerry’s Chocolate Fudge Brownie ice cream. So many friends have asked me how they can save money on their tax returns.
I would assume that this topic would only come up in April when taxes are due, but clearly people ponder over minimizing their tax burden throughout the year.
Adjust Your Withholdings
The first step that I tell people is to pull out their older tax returns, most importantly last year’s.
Check to see if you received a tax refund or owed money the previous year. If you owed money last year, you should adjust your withholdings and monitor your income this year, as you do not want to potentially owe an underpayment penalty. You never want to owe the IRS more money.
Tax Bracket and Long-Term Capital Gains Tax Rate
Warren Buffett famously claims that he pays a lower tax rate than his secretary. He shared that his adjusted gross income in 2015 was $11,563,931. That year, he paid a federal income tax of $1,845,557. This means that he paid an effective tax rate of 16%.
I don’t know about you, but I definitely paid a higher tax rate than that last year. So, how did he do it?
Based on the table below, you can see that both dividends and long-term capital gains are taxed at a rates of 0%, 15%, and 20%. This incentivizes earned income from investments versus a salary.
That is why Warren Buffett pays a lower effective tax rate than his secretary.
Marginal Tax Rate (Tax Bracket) | Long-Term Capital Gains Tax Rate |
10% | 0% |
15% | 0% |
25% | 15% |
28% | 15% |
33% | 15% |
35% | 15% |
39.6% | 20% |
Source: IRS
Tax Shelters: Contribute to Roth Accounts
What are tax shelters? They are retirement accounts, like traditional IRAs and 401(k) plans, which allow you to defer paying your taxes today so that your investments can grow tax-free. Legal tax shelters are always the way to go.
Another way to lower your tax burden in the future is contribute to your Roth IRA and Roth 401(k). While you pay taxes up front, when you withdraw these investments in the future, you won’t have to worry about their tax implications.
However, if you take out a 401(k) loan, make sure that you pay it off before you leave the job. If you fail to do so, that loan amount will be considered a distribution and will be taxed.
Property Tax and Mortgage Interest
Too many taxpayers leave money on the table because they don’t have organized records or they don’t take the time to itemize their deductions. If you own a home, take note of the property tax and mortgage interest payments over the year. This will help you take advantage of the itemized tax deduction in your tax return.
Sell Your Home
This is somewhat unconventional, but if you have lived in your home for at least 2 years, you can deduct up to $250,000 (single filer) or $500,000 (married filer) on your primary residence if you sell. If your house is inching towards these appreciation figures, you may use this as a great excuse to move without incurring additional taxes in the future.
Charity
Donating to charity can allow you to reduce your tax burden. This includes monetary donations along with items, such as clothing, furniture, etc. If you think you’re close to a lower tax bracket, it may be wise to declutter your house and donate some items.
If you plan to give a monetary gift to charity, consider giving an appreciated stock or passive index fund shares that you have owned for one year or longer. This would be more lucrative than simply donating cash. In this scenario, your charitable contribution deduction would be the fair market value of the stock on the date of the gift and not what you paid for it.
However, this does not work in reverse. So, don’t donate stocks or index funds that have lost money. You would be much better off selling the stock and claiming the loss on your taxes than donating these stocks to charity.
Student Loan Interest
You also have the ability to deduct student loan interest to lower your tax burden. This is not bound by the itemized deduction.
Contribute to a Health Savings Account (HSA) or Flexible Spending Account (FSA)
These are established with pre-tax money, which you then use to pay qualifying medical expenses. Contribution limits for Health FSAs are $2,600 for 2017. For HSAs, 2017 contribution limits are $3,400 for individuals and $6,750 for families. More importantly, HSAs can be rolled over the following year without any penalties. Those 55 or older can contribute an additional $1,000.
Have More Kiddos
Of course, I would never suggest making life-altering decisions solely to lower taxes. However, if you are planning to have children, you are eligible to receive an exemption for each one of your dependents. In 2017, this tax deduction is worth $4,050.
On top of that, if you have up to $3,000 worth of expenses for one child, or $6,000 for two or more, while you work or seek work, you can claim the Child and Dependent Care Credit.
Thanks for the great tips. I will make sure to reference this post when I do my taxes next year. The tip about having more kids is interesting. I can definitely see the benefit of tax reduction for more kids. It’s definitely more expensive to raise a kids, but I won’t say no to the extra benefit hehe.
Ms. Frugal Asian Finance recently posted…The Struggle For (Financial) Power In A Marriage
Thanks for stopping by Ms. FAF!!! Kiddos can definitely be expensive to raise. I definitely appreciate the government providing an incentive to defray some of the costs of children 🙂
“The best way to teach your kids about taxes is by eating 30% of their ice cream.”
-Actor/comedian Bill Murray
Nuff said. LOL
Belle recently posted…9 Smartphone Side Hustles – Make $500/Month With These Simple Smartphone Apps
Talk about the tax man cometh. That is hilarious.
Good points here. Unfortunately some of the benefits (like the student debt interest) phase out as we earn more money….the benefit is that we are earning more money.
Dads Dollars Debts recently posted…Hump Day- August 30, 2017
That is definitely a bummer with the student loans being phased out. I never quite understood why student loans phase out buy mortgages don’t.
Glad you enjoyed the quote. It always makes me laugh.
My goal for at least these next few years is to minimize taxes to the extreme. As an early-retired person I have a lot of control over my “income”. The plan is to stick within the 15% bracket this year and pay no cap gains taxes. I think I might be able to pull off an effective rate between 5-8%. We’ll see. 🙂
Brad – MaximizeYourMoney.com recently posted…Here Are 9 Easy Ways To Save Money This Year
Wow if you can reduce your effective rate to 5-8% you will have to write all about it. I would be really interested to see how you do that 🙂
My philosophy has always been, “it’s not how much you earn. It’s how much you get to keep after taxes and deductions.”
Every year, one of my financial goals is to keep more of my hard earned money. I will try to maximize the tax credit that I get and minimize my tax deductions. It takes a bit of time to organize my paper work, but I will get paid at the end.
Leo T. Ly @ isaved5k.com recently posted…Living With Autism
That’s a great philosophy Leo!!! It’s not how much you earn it’s how much you keep 🙂
Bill Murray is one of my favorite actors and that’s a great quote that I havent heard before. I like the HSA suggestion. You could contribute to one even if you already have health insurance. Are there any ways to move the money out of an HSA before retirement without fees if you had to?
Jeff @ Maximum Cents recently posted…How Long Should You Keep Your Car?
I’m not aware of being able to liquidate the account for anything other than medical expenses. Although that would be wonderful you could 🙂
All excellent choices! Another option is to use a tax-sheltered FSA to pay for things like daycare, which will be our plan.
Mrs. Picky Pincher recently posted…Eating Cheap ‘N’ Healthy Without Hating Yourself
Great idea Mrs. Picky Pincher!!! That’s a great way to cut down on the cost 🙂
The one thing I’d add is pay attention to timing. If you have a year where your in a higher bracket pull forward next year’s property tax or delay a stock sale a few weeks. Vice versa can also be of benefit.
FullTimeFinance recently posted…Luck And Preparedness
Great points FullTime Finance!!! Timing when you buy or sell things is HUGE!!! Paying attention to where you stand is so important.
Great post! The best hidden secret among the wealthy (and I think we should know as PFers) is the cap gain. Charity is an excellent way to go if you are itemizing.
Lily He-Prudhomme recently posted…One Perpetual Frugal Fail – I Hate My Clothes & What I’m Going To Do About It
Capital gains are so huge. Especially if you can carve out some of those exemptions 🙂
Tax shelters are great because they are a double whammy; you’re forcing yourself to save for your future and getting a tax break (if you use tax-deferred accounts) to not pay taxes up front. Also, it’s good to put high dividend paying securities their too to take full advantage of this rule 🙂
SMM recently posted…Best 401k Calculator
Great point SMM!!! We definitely take advantage those dividends and turning on the DRIP. It’s a wonderful feature 🙂
It is not even September yet, but it is not too early to start planning for tax season. You have provided a great list of options for tax savings and deferrals. There really are so many ways for average earners to reduce their tax bill.
Dave recently posted…How the Mob Influenced My Asset Allocation
Thanks Dave!!! I know it’s a couple of months away before the end of the year. But I figured it’s never too early to prep up 🙂
I think more people should consider donating unused stuff to charity. You get two benefits from doing this. Lowering your tax bill and also freeing up more space in your house.
It’s a win win! Oh, and you get to support others in need to. Almost like a mini hero.
Cory @ Growing Dollars From Cents.com recently posted…The Best Legitimate Survey Sites To Easily Make Money In Your Free Time
Thanks Cory!!! I totally agree that donating is a huge win/win. Getting rid of stuff that you don’t use is a great way to clean up the house and provide valuable things to others.
I’d point out that a lot of these phase out at higher incomes…Roth IRA contributions, student loan interest, and even the child tax credit. Sheltering your money in 401(K)s and HSAs don’t, however.
One of the best things I’ve seen is that if you are planning to go back to school and you live in a state with a 529 deduction, open a 529 for yourself and stream your qualified expenses that you’re cash flowing through the 529.
Emily Jividen recently posted…Your Fall Holiday Money Plan: Prepare Now or Pay Later
Great points Emily!!! The 529 plan is definitely something I wish I did when I went back and got my MBA. It definitely would have saved me a couple of dollars along the way.
Hello
Tax return and payment deadlines become much important for a sole trader. Also a trader must be try the ways for decrease tax bill.Such a informational and interesting content,thank you so much for posting this!
soba recently posted…Federal Budget 2017: Proposed Tax Changes for Private Corporations in Canada
Glad you enjoyed the article Soba!!!
There’s no way to sugarcoat it: if you purchase a home you’ll have to start paying property taxes. Your property tax liability will depend on where you live and the value of your property.
You are absolutely right!!! BTW…I was just in Sydney and it was beautiful!!!
In some places, assessments are conducted regularly, while other places go decades without an assessment and people in the area would love to pay lower taxes based on a re-assessment of their home’s market value.
Sydney depreciation schedule recently posted…Want to Get Hired in Real Estate? Here’s What You Can Apply For
Where I live they do a yearly assessment. So I wish we went years before we had another assessment 🙂
I learned about Emergency Funds and then realized this is what everyone should do. SAVE! Save for a rainy day
I’ll learn more about student loan interest, going to enter university next year. Thank you!