An unexpected or unusually high tax bill is never welcomed with open arms from a taxpayer. But good news, while everyone’s tax situation is different, there are options available to most taxpayers to help reduce their taxable income. Here are seven great tips from a Certified Public Accountant (CPA) to help you lower your tax bill.
1. Prioritize Saving For Retirement
Contributing to your employer provided retirement plan (401K, 403b, 457, etc.) will transfer pre-tax money into your retirement account. These contributions will reduce your taxable income and thus lower your tax bill.
A Very Basic Example:
- If I have a salary of $100,000 per year and opt in to contributing $10,000 to my 401K, come tax time my tax return will report an income of $90,000 vs. the actual income I earned of $100,000.
- Because I made a pre-tax contribution to my 401K, I reduced my taxable income, my current year tax bill AND now my retirement assets will grow tax deferred until I withdraw them during retirement.
- For 2022, you are able to contribute up to $20,500 directly into your employer provided retirement plan. If age 50 or older, you can contribute up to $27,000.
- For 2023, the max contribution will be $22,500. If 50 or older, your max contribution will be $30,000.
Note: This is NOT applicable to Roth (After Tax) retirement accounts.
2. Fund Your FSA, HSA Or DFSA
The IRS provides a number of different opportunities for taxpayers to shift pre-tax money to other vehicles – such a Flexible Spending Account (FSA), a Health Savings Account (HSA) and a Dependent Care Flexible Spending Account (DFSA). IF your employer offers these types of accounts, you might want to take advantage of them if you are eligible in order to lower your tax bill.
- Flexible Spending Account (FSA):
- A FSA is a special account you put pre-tax money into that you can use to pay for certain out-of-pocket health care costs throughout the year.
- FSAs are limited to contributions of $2,850 per year, per employer
- You generally must use the money in an FSA within the plan year, but some employers may offer an opportunity to carry over the funds to the next year.
- Dependent Care Flexible Spending Account (DFSA):
- A DFSA is a special account you put pre-tax money into that you can use to pay for eligible dependent care services, such as preschool, summer day camp, before or after school programs, and child or adult daycare.
- You could save an average of 30 percent on dependent care services
- The contribution limits for 2022 are: $5,000 per year per household. $2,500 for married individuals filing a separate tax return.
- Health Savings Account (HSA):
- A health savings account is a tax-advantaged medical savings account available to taxpayers who are enrolled in a high-deductible health plan. The funds contributed to an HSA are made pre-tax, the funds grow tax FREE and withdrawals are made tax FREE so long as they are used for qualified medical expenses. Refer to a previous blog post on Health Savings Accounts.
- For 2022, if you have a high deductible medical plan, you can contribute up to $3,650 for self-only coverage and up to $7,300 for family coverage into an HSA. HSA funds roll over from year to year.
NOTE: You are typically NOT able to contribute to both a Flexible Spending Account AND a Health Savings Account. Confirm with your employer as it will be dependent on their FSA plan.
3. Save for Children’s College Education With a 529
A 529 College Savings Plan is a tax advantaged investment account that’s sole purpose is to pay for higher education costs.
- Your contributions and growth within the investment account will be benefit from tax free growth for years to come so long as the future withdrawals are made towards qualified education expenses.
- Your contributions to a 529 college savings plan will not be tax deductible at the Federal level BUT it may be fully or partially tax deductible at the State level depending on the state you live in and the state 529 plan you have chosen.
Check out the Saving for College website to learn how much tax benefit you may receive for your 529 contributions.
Refer to a previous blog post for more information on 529 College Savings plans.
4. Tax Loss Harvesting
In times of market volatility or downturns, you may see some losses in your account. I am a long term investor and will rarely sell any positions unless I no longer have conviction in the investment, my allocation needs tuning OR I am able to do some tax loss harvesting.
Tax loss harvesting is the process of selling securities at a loss and being able to receive some form of a tax benefit as a result.
- You can deduct losses on sales of securities, which can offset any taxable capital gains you might have OR can offset your ordinary income by up to $3,000.
An example of tax loss harvesting:
- Let’s say I purchased shares of Microsoft for a total of $1,000, but now they are worth $500. I have an unrealized loss of $500.
- I want to own Microsoft, but I also want to take advantage of the loss. I sell Microsoft, recognize a $500 loss and I buy an S&P 500 ETF, like VOO. Two benefits: I’m still invested AND I recognized a loss to lower my tax bill.
- But I still want to own Microsoft, so I wait 31 days to avoid the wash sale rules, and I sell my VOO and buy Microsoft again.
Keep in mind that the IRS doesn’t allow you to take the losses when you purchase the same or “substantially similar” investment within 30 days before or after the loss. You need to wait 31 days to reinvest in the same security in order to benefit from the loss.
5. If You Are Self Employed – Consider a Solo 401K or SEP IRA
If you are self employed, have had significant business success this year and now have some extra cash….consider setting up a retirement plan through your company by way of a Solo 401K or SEP IRA.
- The contributions to these retirement vehicles will benefit you in two ways – you will be contributing to YOUR retirement fund AND you will be reducing your business taxable income and will lower your tax bill. Win win.
Set up a meeting with your CPA or Tax Advisor to help guide you in setting up and funding your Solo 401K or SEP IRA.
6. Charitable Contributions
IF you itemize your deductions, making charitable contributions is another great way to lower your tax bill.
You can donate cash, household items, appreciated securities, clothes, etc. to a qualified charitable organization and in turn receive a tax benefit for doing so.
7. Maximize Your Business Deductions
If you are a contractor receiving a 1099 or if you have your own business – you have an advantage that will allow you to offset your business income by reasonable business expenses.
- Think supplies, travel, mileage, home office expenses, cell phone, etc. All of these expenses will add up and will offset your business income and as a result, will lower your tax bill.
- Do not spend for the sake of spending…but consider your financials and cash reserve at the end of the year and determine if there are new supplies or equipment, etc. that are needed that could be prioritized before the end of year to reduce your business income.
Intentionally Direct Your Money & Lower Your Tax Bill
For most of the options above, you have until December 31st to take action! Meet with your CPA or tax advisor before the end of the year to tax plan and help execute on some of the items listed above.
Hope you found this post on 7 tips to lower your tax bill helpful!
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