6 Ways to lower your taxes this year
While 2020 winds down, there is still time to reduce your tax burden. Here are six ideas that can save money for most of us.
1. Leverage pre-tax savings.
Take advantage of opportunities to set aside income on a pre-tax basis. This includes;
- Participation in your employer’s retirement savings program.
- Fully funding Health Savings Accounts (HSA), and “Flex Benefits” accounts that allow using pre-tax earnings to pay for childcare and out-of-pocket medical costs. Remember, however, unlike HSAs it is important to use up any funds in your Flex health care accounts and dependent care accounts prior to the end of the plan year as any unused funds will be forfeited.
- Take full advantage of employee benefits like pre-tax child care, parking reimbursements, and any tuition reimbursement programs.
- Paying any health care costs with pre-tax dollars.
2. Defer Income and Accelerate Deductions (or vice versa).
When possible think about whether it is better to reduce taxable income in this year or next year. By understanding which tax year will be more advantageous to you, you can act to defer income into a subsequent tax year and accelerate deductible expenses into the current tax year. On the other hand you may believe tax rates will be higher next year. If this is the case you will want to move as much income into the current year and defer expenses. Here are some ideas if your strategy is to minimize taxable income this year:
- Delay receipt of a bonus check
- Make an extra house payment
- Make extra charitable contributions (that you would make anyway)*
- Make next year’s church donations this year.*
- Make extra trips to donate non-cash items prior to January 1st*
- Review your investments to book gains and/or losses
*Note: With higher standard deductions, many of you will not be itemizing deductions each year. If this is you, consider bundling two or three years of deductions into one year. This is especially beneficial with charitable contributions.
3. Harvest gains and losses.
Each year up to $3,000 in investment losses can be used to offset ordinary income. This is done after using the tax code’s netting rules. Furthermore, any donation of appreciated stock can avoid paying tax on the capital gains of the donation. Make full use of this knowledge to make tax efficient moves with any investment gains and losses.
4. Maximize tax-exempt and tax-deferred Investments.
The higher your tax bracket the more tax savings you’ll realize with tax exempt and tax deferred contributions such as employer sponsored 401(k)s, IRA’s, tax-free municipal bonds, and Section 529 College Savings Plans.
5. Make full use of your marginal tax.
The U.S. ordinary income tax has seven different tax rates with a maximum rate of 37%. The higher rates are like stairs, you go to the next highest rate instantly, when you pass a dollar amount. Knowing this, make full use of a lower rate until you step up to the next level. Those that are taking money out of retirement accounts should make full use of this idea.
6. Avoid Penalties.
The IRS has become penalty crazy, as our tax system slowly migrates from a voluntary compliance system to a punitive one. For instance the minimum failure to file penalty has increased from $100 in 2009 to $435 in 2020. So avoid costly penalties and interest charges getting your tax records in order now. That way filing on time will be a breeze.