Initial analysis of the Tax Cuts and Jobs Act of 2017 implied that take-home pay would go up for many Americans and that overall taxes would go down — at least for some people. Plenty of people are still freaking out about getting a smaller tax refund this year.
If you’re paying attention to your actual tax bill and not just the size of your refund, you should strive to do everything possible (within reason) to maximize your income and reduce how much you owe. Fortunately, the Internal Revenue Service (IRS) offers plenty of ways to reduce your taxable income and your tax bill — many of which can also boost your savings rate.
Consumers who want to pay a lighter tax bill next year should also act now, before it’s too late. These are just a few examples of how you could whittle down next year’s tax bill, but there are plenty of others. If you’re not sure exactly what you should do, your best bet is sitting down with a tax professional now to craft a plan that will yield tax savings for years to come.
1. Start saving for retirement in a tax-deferred retirement plan
Dave Du Val, EA and Chief Customer Advocacy Officer at TaxAudit, says one of the best steps you can take to reduce your tax bill is contributing to a tax-deferred retirement plan like a 401(k) or SEP IRA. Contributing to a tax-deferred account allows you to deduct contributions from your income, which will help you reduce your taxable income and save on your tax bill.
You’ll also boost your savings rate and speed up the journey toward retirement, plus put yourself in the best position to harness the unstoppable power of compound interest. Better yet, some employers may even “match” a certain percentage of your retirement contributions, which is the closest thing to “free money” you’ll ever find.
Because retirement contributions are taken out of your paycheck on a pre-tax basis, you may not even notice a huge difference in your take-home pay.
2. Set up an efficient system to track your ordinary and necessary business expenses
It’s easy to let your business expenses become disorganized if you don’t keep track all year, leading to a frenzy of receipt-searching and stress come tax time. Du Val says you should set up a system now to keep better track of expenses that are deductible or may be deductible.
“Many taxpayers are cheating themselves out of ordinary and necessary expenses as they do not remember them a year later when they are preparing their taxes,” he says.
Obviously, these missed deductions translate into higher taxes you could avoid with some better organization and planning. There’s no perfect system — you can use an app like Mint or Personal Capital, a spreadsheet of your own making, or a simple pen and paper. Whatever you’ll actually use regularly is the best choice for you.
3. Incorporate your small business
If you have a small business but haven’t yet incorporated, there could be valuable tax benefits for doing so. Emil Abedian, founder/CEO of Anchor Bookkeeping, says running your small business as a S-corporation could potentially save you tens of thousands of dollars, for example.
This is due to the fact that, as a sole proprietor, you pay Social Security and Medicare taxes of approximately 15% on your entire income up to approximately $130,000. After the $130,000, the Social Security percentage disappears, and you pay Medicare taxes (2.9%) on your entire income.
On a $150,000 profit, you will end up paying more than $20,000 in Social Security and Medicare taxes in addition to income taxes, noted Amedian. However, if you run your business as an S-Corporation with the same income under the assumption you will take a “reasonable” salary of $75,000 and have the remaining profit distributed to you in the form of profit distribution, you could end up saving close to $10,000 in taxes per year.
“The lower you can justify the reasonable salary, the more the tax savings will be,” he said.
4. Pay your spouse or kids for their work
If your business is a family affair, you should treat it that way come tax time.
“If your spouse or kids work for you, make sure you pay them through payroll so that they can have the option to defer income for retirement,” said Abedian.
The wages you pay them become a tax deduction for your business, which helps you reduce your taxable business income. If they in turn decide to put their salary in a 401(k) or IRA account, they can defer taxes on that income even further.
“This could save the family lot of money,” said Abedian.
5. Max out your retirement savings, including ‘catch up’ allowances
If you’re already saving for retirement but want more tax savings, consider boosting your contribution percentage or even maxing it out. The IRS increased the amount you can contribute to a 401(k), 403(b), and most 457 plans to $19,000 in 2019, up from $18,500 the year before. Traditional IRA contributions, which may also be deductible on your taxes, also received an annual boost up to $6,000.
Also be aware that many retirement accounts let you contribute more if you’re ages 50 or older. With a 401(k), for example, you can save an additional $6,000 per year in catch-up contributions. With an IRA, the catch-up component allows for an additional $1,000 in annual savings.
6. Be strategic with charitable contributions
Tax attorney Megan Gorman of Chequers Financial Management, a High Net Worth Tax and Financial Planning firm, says it’s crucial to be intentional when it comes to charitable giving if you hope to maximize the tax benefits of your contributions.
If 2019 is going to be a significant income year, for example, but you don’t believe 2020 will be, you may want to consider “bunching” your contributions into a single year, she says. The driver behind this is the newly doubled standard deduction, which requires taxpayers to have a lot more deductions to itemize. You have to itemize to be able to deduct your charitable contributions, so bunching them all in a single year can help you reach that threshold.
You can also utilize a donor advised fund to hold the funds until you are ready to disperse to charity, said Gorman. “The benefit is that, when you fund the donor advised fund, you get the charitable donation,” she said.
Fidelity’s popular donor-advised fund makes it easy to set aside funds now for future charitable contributions.
7. Contribute to a health savings account (HSA)
Certified Public Accountant Riley Adams, who also blogs at Young and the Invested, wants to remind taxpayers it’s never too late to open a health savings account, or HSA.
To qualify, health insurance plans must have a minimum deductible of $1,350 for individuals and $2,700 for families, plus a maximum out-of-pocket of $6,750 for singles and $13,500 for families in 2019.
If your health insurance plan allows you to contribute, individuals can save $3,500 per year and families up to $7,000 on a tax-deferred basis. Your money then grows tax-free until you remove it from the account to cover qualified healthcare expenses.
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SOURCE: Business Insider