There are only two things that are certain: death and taxes. Now some folks will say paying taxes is patriotic; and, while I’ll concede we all have a moral and legal obligation to pay our taxes, I hardly consider paying more taxes patriotic. Personally, I subscribe to the philosophy that this obligation is to pay the minimum amount of taxes!
Take the necessary actions to ensure you pay the minimum, legally required amount of taxes.
The taxes that you pay to local and state governments are going to be based on three things:
- The amount of your income
- The amount of deductions from your income
- The amount of your tax credits
Minimizing the impact of your taxes requires managing each one of these elements carefully. Let’s take them one at a time.
The Effect of Your Income on Taxes
First, we start with income. While you would like the amount you earn to be as high as possible, there are a number of ways to structure this income to minimize the tax bite. For example:
- You can maximize your contributions to 401(k) plans and have this reduce your taxable income (an added bonus is that many 401(k) contributions come with some sort of match from your employer).
- You can contribute to a traditional IRA and have this reduce your taxable income.
- You can participate in other non-qualified compensation plans that reduce your taxable income.
- You can structure your employment contract to equalize income in a manner to avoid moving into higher tax brackets during a given year.
- You can structure your investment transactions (e.g. stock sales, option exercises, etc.) in a manner to minimize the tax impact.
Effectively implemented, each of these techniques will enable you to play less taxes. (For related reading, see: Top 5 Ways to Reduce Your Taxable Income.)
Using Deductions to Reduce Tax Liability
Second, you can take advantage of deductions to minimize the impact of taxes. For example:
- In many states you can contribute to a 529 college savings plan and have your taxable income reduced.
- You can maximize your itemized deductions on your federal taxes. Make sure to claim:
- Home interest paid
- Property taxes paid
- State income taxes paid
- Car registration fees paid
- Medical expenses
- Investment advisor fees
- Work with a good CPA that has knowledge of other specific deductions available for your situation
- Claim any investment losses. Investment losses of up to $3,000 can be used to offset income.
- Business deductions. There are a variety of business expenses that may be claimed to offset income. (For related reading, see: 5 Little Known Ways to Reduce Small Business Taxes.)
Take Advantage of Tax Credits
Finally, in some instances, you can take advantage of tax credits. Top among the available credits are:
- In some states contributing to 529 college savings plans actually result in a tax credit.
- The child care tax credit can be worth up to $1,000 per child.
- The adoption tax credit can be worth up to $12,970
- The small business health care tax credit. If you run a small business and provide health care for your employees, you can claim up to 35% of the cost of this benefit in certain situations.
While death and taxes are a certainty, there’s no obligation to pay excessive taxes prior to meeting the grim reaper. A good accountant working together with a skilled financial planner can help you to significantly minimize the impact of taxes.
(For more from this author, see: How to Plan for Your Child's College Education.)