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|
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.
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.