With tax season in full swing, many taxpayers look for ways to reduce the amount in taxes they have to pay this year. It's great to save money on taxes, but you also want to keep your long-term financial health in mind when looking for saving opportunities.
If you want to reduce your taxable income but don't know where to begin, the following areas are a great place to start. (For related reading, see: Top Tax Deductions Not to Overlook and Tax Calculators and Preparation Tips.)
Saving for Retirement
You likely already know this, but saving for retirement is one of the best ways to reduce your taxable income. Retirement planning presents many opportunities to save money on taxes that benefit you in the long run. Some of those opportunities are:
The IRS allows individuals under 50 years of age to set aside $18,000 for the 2015 tax year in a 401(k) plan, with an additional $6,000 for those over age 50. IRAs, on the other hand, allow those under 50 to set aside $5,500 and those over 50 an additional $1,000. “This accomplishes two goals: reducing current taxable income while also putting away money for your future," said CPA Kaitlin Krozel of Krozel Capital. "If your employer offers a 401(k) plan, every dollar that you contribute reduces your taxable income. If you are self-employed and a sole proprietor, consider opening and contributing to a SEP-IRA or solo 401(k) as contributions are also deductible.”
While medical costs continue to surge, there are opportunities to save money on taxes, depending on your health insurance situation. If you have a high deductible health plan, you may qualify to open a health savings account (HSA). The IRS allows contributions for the 2015 tax year of $6,650 for families and $3,350 for individuals with a $1,000 catch-up allowed for those over age 55.
The benefit of an HSA is that it offers a triple tax advantage, meaning contributions and earnings are tax-free plus any qualified expenses can be withdrawn tax-free.
If you do not have a high deductible health plan, a flexible spending account (FSA) is an option; it features a contribution limit of $2,550 for individuals and families alike. (For related reading, see: Estimated Tax Deadlines for 2016.)
When You Move
Did you move in the past year due to a job change or the launch of a new business? If you meet requirements dictated by the IRS, you may be able to deduct what it classifies as reasonable moving expenses. “Unlike many deductions that are included as itemized deductions on Schedule A and have limited benefits, this is a dollar-for-dollar adjustment to income that comes into play right on the front page of the 1040,” said Crystal Stranger, President of First Tax.
In many instances, it's foolish to buy something simply to get a tax deduction. This is especially the case for home-based businesses that rationalize buying something because it's tax deductible. That being said, if you genuinely need a business item and it's something you've already budgeted for, getting a tax deduction can be a benefit. Just be aware of what qualifies before the purchase, so you get a full benefit.
Give to Charity
If you have a charitable organization you support, giving to the cause can allow you to lower your taxable responsibility. Cash isn’t the only contribution type that qualifies either: “…charitable contributions are deductible and can be made in ways including cash, checks, donations of clothing or other items, even payroll deductions," said Joe Eppy, founder of The Eppy Group. "These deductions can add up, and many times people forget about them.”
The IRS allows you to deduct up to 50% of your income though lower limits will occur in some cases. Do your due diligence prior to making a decision to know the deduction available to you.
The Bottom Line
Reducing your taxable income through various ways can be a wise move when done with a long-term mindset. Make sure to consult a tax professional prior to making any decisions. (For related reading, see: How to Avoid the 6 Most Common Tax Audit Triggers.)