10 ways to cut your tax bill
Every way you can find to trim your tax bill means extra cash back in your pocket. Here are 10 tax-cutting strategies that could really pay off.
1. Contribute to a retirement plan. Funding your retirement accounts isn’t just important for your future, it can also work wonders for your tax bill. If you open a traditional IRA or participate in an employer-sponsored 401(k), the money you contribute will go into it tax-free, which could amount to some pretty serious savings. Currently, anyone under 50 can contribute up to $18,000 annually to a 401(k) and $5,500 to an IRA. Workers 50 and older get a catch-up allowance that raises these limits to $24,000 and $6,500, respectively. If your effective tax rate is 25 percent and you put $5,000 into either type of account, you’ll get $1,250 in instant tax savings.
2. Be charitable. Supporting your favorite causes won’t just make you feel good; it’ll help you lower your taxes. Any time you donate to a registered charity, you can take a deduction for the amount you give away. Don’t have cash to contribute? Clean out your attic and cull your closets, because you can also take a deduction for donating goods, provided you retain a detailed receipt. That said, make sure to only claim the current fair market value (not the original cost or value) of the items you’re parting with.
3. Take advantage of homeowner tax breaks. Homeownership can pay dividends from a tax perspective. First, you can deduct the interest you pay on your mortgage, provided your loan doesn’t exceed the $500,000 mark if you’re a single tax filer, or the $1 million mark for couples filing jointly. You can also write off your property taxes, and any points you paid on your mortgage. Finally, if you’re paying a private mortgage insurance (PMI) premium (which banks require when your down payment is below 20 percent of your home’s purchase price), you can claim a deduction for it as long as your income is $54,000 or less as a single filer, or $109,000 or less a couple filing jointly.
4. Keep track of your medical expenses. Paying for healthcare is a significant burden for countless Americans, but if you rack up enough out-of-pocket expenses, you at least get a decent tax break. Specifically, you can take a deduction for medical costs that exceed 10 percent of your adjusted gross income (AGI). If your AGI is $100,000 and you spend $11,000 on medical care, you can write off any costs that exceed $10,000 -- which, in this case, would leave you with a $1,000 deduction.
5. Hold investments for more than a year. Any time you make money on an investment, you’re required to pay the IRS its share in taxes, but the length of time you held your investments could impact the rate at which you’re taxed. Investments held for one year or less are considered short-term capital gains and taxed as ordinary income. This means that if you typically land in the 25 percent tax bracket, that’s the rate that will be applied to your short-term gains. But if you hold your investments for at least a year and a day before selling, you’ll only have to pay long-term capital gains taxes, which are considerably lower. Most Americans pay just 15 percent on long-term capital gains. Higher earners, meanwhile, are currently capped at 20 percent, and low earners don’t pay taxes on long-term capital gains at all.
6. Use investment losses to offset gains. If you have a poorly performing investment taking up space in your portfolio, unloading it could cut your tax bill. First, you can use investments losses to offset comparable gains -- which means that if you’re looking at a $2,000 gain and a $2,000 loss, they’ll simply cancel each other out and remove the tax burden triggered by your initial profit. But just as importantly, if your net investment losses exceed your gains during any given tax year, you can use up to $3,000 of them to offset your ordinary income. And if you’re still left with a net loss after that, you can carry the remainder over into future tax years.
7. Open a flexible spending account. We all inevitably spend some money each year on medical care, but if you open a flexible spending account (FSA), you can arrange to pay for those expenses with pre-tax dollars, thus lowering your overall tax bill. For 2017, you can put up to $2,600 into an FSA. If you think you’ll rack up that much in medical bills, and your effective tax rate is 25 percent, maxing out your FSA will result in a $650 tax savings. The only catch is that FSAs are funded on a use-it-or-lose-it basis, so if you overestimate your costs and don’t wind up spending the full amount you put in, you risk forfeiting some or all of your balance. Employers have the option of allowing you to carry over up to $500 from one year to the next, but not all do.
8. Sign up for commuter benefits. Most people spend money to get to work, but if you sign up for commuter benefits through your employer, you can use pre-tax dollars to cover some or all of your costs. Currently, you can allocate up to $255 each month for transit (such as your bus or rail pass) and $255 each month for parking, for a combined monthly total of $510.
9. Know your tax credits. Unlike tax deductions, which work by excluding a portion of your income from taxes, tax credits give you a dollar-for-dollar reduction of your tax liability. There are numerous credits available to taxpayers, particularly for low earners, students, and folks with dependents, so it pays to do your research and see which ones are available to you.
10. Save for college with a 529 plan. Opening a 529 plan can save you money on taxes in more ways than one. First, your contributions get to grow on a tax-deferred basis, which means that if your investments make money between now and when your child goes to college, you won’t be required to pay taxes year after year along the way. Furthermore, while you won’t get a federal tax break on the funds you contribute to a 529, most states offer some sort of tax deduction to residents who participate in their local plans. And if you live in Arizona, Kansas, Maine, or Pennsylvania, you’ll get a deduction for participating in any state’s 529 plan. Better yet, three states -- Indiana, Utah, and Vermont -- will actually give you a tax credit for making 529 plan contributions.
We all want to lower our taxes. Follow these tips, and you could shield hundreds or thousands of dollars from the IRS’s reach.