Now that tax day has come and gone, are you comfortable with the outcome? If not, there are plenty of things you can do now and steps to take to set yourself up for a successful tax day in 2018. At the beginning of each tax year ask yourself, “What are the deductions I can take to reduce my taxable income?” There are a few things to consider to improve your tax situation for the year ahead.
Utilize Pre-Tax Savings Vehicles
One of the biggest and most beneficial ways to reduce taxable income is to defer as much money as possible into an employer-sponsored retirement plan. The current maximum contribution limit is $18,000. That’s a lot of money and I know people think, “I’ll never be able to put away $18,000.” But it’s important to aim for that goal because it will reduce taxable income dollar for dollar. And a catch-up provision is available for those aged 50 and older, which allows them to contribute an extra $6,000 per year.
Contributing the maximum to a company retirement plan has more benefits than simply reducing taxable income. By doing so, you are setting yourself up for a more comfortable retirement by saving and investing a healthy portion of your current income in the future. Another simple way to reduce taxable income is contributing to a health savings account (HSA). HSAs and 401(k)s are treated similarly for tax purposes. What you put into an HSA account goes toward reducing your taxable income.
Maximize on Charitable Donations
Are you charitably inclined? Giving to charities of your choice is the second biggest way to reduce your income. Are you interested in 501(c)(3) organizations? When contributing to qualified organizations, be sure to keep track of donations as they may have the power to reduce your income dollar for dollar. Find a system that works for you, whether it’s an Excel spreadsheet or printing and keeping receipts, as donations can add up quickly. If you make donations throughout the year and don’t keep track, when April comes around and it’s time to gather your deduction info, chances are you won’t remember how much you donated or to whom. (For related reading, see: Give to Charity; Slash Your Tax Payment.)
Reduce Passive Taxable Income
So, you’ve already put as much as you can into a 401(k) and you’re keeping track of charitable donations. Next you’ll want to look at ways to reduce passive taxable income. If you have money invested in bonds that pay interest, like corporate bonds, that interest is taxable. Depending on your tax rate, you may want to consider putting money into a municipal bond. For federal income tax, interest paid by municipal bonds is tax-free. Additionally, if the bond is from the municipality where you live, then it is also free from state income tax. For example, if you are a Pennsylvania resident who purchases a Pennsylvania municipal bond, that bond is free from state and federal tax.
Offset Capital Gains
One final thing to do is to offset taxable gains. If you’ve taken any capital gains on your investments throughout the year, you may be able to offset those gains through tax-loss selling. The way this works is to identify investments that have declined in value since you first purchased them and sell those investments at a capital loss in order to offset the capital gains earned in that year. This may sound counter-intuitive because we never want to take a loss, but if any investments did lose value, then you can take advantage of that to offset any gains you may have reaped. For example, say you sold a stock in June and you earned a $10,000 capital gain, that’s great, but it’s taxable. Fast-forward to December. You may have made an investment that wasn’t as successful. Sell it and use that amount to offset the gain you received in June. Then, if you still really like the stock, simply wait 30 days and buy it back.
There are a number of different strategies that people can employ to reduce their taxes. Start off with these tactics and always consult your accountant or tax advisor if you have questions throughout the year.
(For more from this author, see: How Retirement Planning is Like Playing Football.)