What are some ways to minimize tax liability?
It is a question we should ask ourselves on a yearly basis. Some of the great suggestions already posted are:
- Increased pre-tax contributions to your work's retirement plan
- Charitable contributions
- Maximize your itemized deductions
- Increased pre-tax contributions to your own business or side hustle
- Max out your traditional IRA contributions
Other things to consider:
- The use of an HSA Plan -- tax-free for healthcare, tax-deferred for retirement after age 65
- The use of US Savings Bond, I-Bonds if you need inflation protection -- they can be tax-deferred for 30 years
- The use of 529 Plans -- tax free for most education expenses, tax deferred for those with scholarships (some use for estate planning)
- Gifting assets -- if you are in that position to do it and in that part of your life (be careful of gift-tax limits)
- Hold more heavily taxed assets in retirement accounts (bonds, dividend paying assts, or high turnover funds)
- Max sure your taxable assets are in tax-managed or tax-friendly assets where possible
Many clients will avoid taxes to the detriment of a good long-term plan. Taxes are never good, just make sure you are not avoiding good investments or planning just to avoid them – the tail wagging the dog. One thing that might help is to run your future tax scenarios through planning software. Using a fee-only professional from www.napfa.org is best, but you can look at doing it yourself too. Our website offers free three-month access to our planning software:
Mark Struthers CFA, CFP®
Minimizing tax liability is one of the most important financial planning aspects for business owners and individuals each year, but it can also be a confusing process. Tax credits and deductions are often overlooked when filing taxes each year, and miscalculations or misinterpretations of tax guidelines can end up costing taxpayers more than they may have bargained for. Although it is not exhaustive, the following list of common tax planning strategies can help some taxpayers minimize their taxable liabilities each year.
Increase Retirement Contributions
The easiest way to reduce gross income is through additions to an employer-sponsored retirement plan or contributions to an individually held traditional IRA. Tax benefited plans such as a 401(k) or a 403(b) offered through an employer allow employees to contribute pretax dollars up to a maximum of $18,000 for the 2015 tax year; for those over the age of 50, an additional $6,000 can be added as a catch-up contribution. 401(k) or 403(b) additions are made through paycheck deferrals and offer a direct dollar-for-dollar reduction to total taxable income, which results in a greatly reduced tax liability each year contributions are made.
If an employer-sponsored plan is not available or an individual is self-employed, contributions can be made to a traditional IRA instead. These additions are also made on a pre-tax basis, resulting in the same direct reduction to taxable income, and ultimately total tax liability. For the 2015 tax year, contributions cannot exceed $5,500, with an additional $1,000 allowed for those age 50 and above.
Transition Non-Qualified Investments
Investment gains derived from dividend and interest payments can be an expensive burden as it relates to total tax liability; however, taxpayers with sizable non-qualified investment accounts can transition assets to vehicles that provide a greater degree of tax shelter. For example, moving from a high turnover mutual fund that is not efficiently tax managed into a tax-exempt bond fund may prove less costly in the long run as dividends and interest are exempt from federal and, at times, state tax. Additionally, selling off investments that have declined in value can help in reducing total tax liability each year, as investment losses can be written off against ordinary income up to a certain limit. It may also be beneficial to hold off on selling an appreciated asset to avoid creating a taxable event in a year when taxable income is already high.
Donate to Charity
Making contributions to qualified charitable organizations can also provide taxpayers with deductions each year. Individuals have the option to donate cash as well as new or used household items to non-profit entities in order to reduce total tax liability. However, any donation that has a value exceeding $250 requires a receipt to be a valid deduction, and donations above and beyond 20% of adjusted gross income are limited.
To reduce tax liability, individuals have the opportunity to take advantage of these tax strategies any time throughout the tax year. The use of a CPA or other tax professional is highly recommended to ensure tax deductions are applied correctly. Similarly, an investment professional may be able to provide additional insight into the most appropriate strategies for restructuring assets during the year.
It is tax time and deduction can help save you money. Many legal deductions go unclaimed each year, because most Americans still don’t know they exist. From cost savings for eyeglasses to approved deductions for airline baggage fees, no matter who you are, you’re likely to find at least one applicable deduction on the list below—and odds are you qualify for more than one. So read carefully, the savings can add up…
• Job-hunting costs are applicable expenses that can be added to your itemized deductions. Did you spend out-of-pocket costs traveling to interviews or spend money stationery for resumes and cover letters? If so, deducting these items can make a big dent at tax time. And one doesn’t have to be officially unemployed to qualify. Searching for a better job, even while fully employed, is perfectly acceptable. Other applicable deductions include food and lodging for overnight stays, cab fares, and employment agency fees.
•If that new job is your first job, any incurred moving expenses may indeed be deductible. To qualify for the deduction, your first job must be 50 miles or more from your previous residence. Those who qualify can deduct the cost of moving and, if you drove your own vehicle for the move, deduct 17 cents (2017) a mile plus parking and tolls.
• While everyone recognizes that necessary medical items like wheelchairs and hearing aids may be deducted, few realize that eyeglasses and contacts also fall into the same category. While designer eyeglasses, or drug store magnifiers, may not seem like medical devices, the IRS does allow these deductions – a big cost savings at tax time.
• Though we all know charitable contributions are tax deductible – one of the most common ways that Americans gain tax deductions – many less obvious acts of charity also qualify. Out-of-pocket charity expenses such as the cost of paint and poster board for a school fundraiser, or the cost of delivering meals or chauffeuring other volunteers can be deducted. Such mileage deductions may be totaled at a rate of 14 cents (2017) per mile plus parking and toll fees. Deductions will require a written acknowledgement from the charity involved.
• Members of the National Guard or military reserve may claim a deduction for travel expenses to drills or meetings. In order to qualify, the service member must travel more than 100 miles from home on an overnight journey. Applicable deductions include lodging, meals, and 53.5 cents (2017) per mile plus parking and toll fees.
• For those employees who have served on juries in the past year, jury duty may represent a taxable deduction. Many employers continue to pay their employees during the time of jury proceedings, but require the employees to turn over jury pay as a recompense for the time away. To even things out, you can deduct the amount you give to your employer. In such cases, the write-off goes on line 36 – the line totaling up deductions that get their own lines. Add your jury fee total to your other write-offs and write "jury pay" on the line directly to the left.
• Airline baggage fees are another deduction that is rarely recognized by the American traveling public. All told, these fees can add up to serious costs. If you're self-employed and traveling on business, you can add those costs in as approved business deductions.
• In most cases, one can only deduct mortgage or student-loan interests if one is legally required to repay the debt. But if you’re a non-dependent student who still receives help from mom and dad, you parent’s generosity may help you at tax time. If mom and dad pay your loans, the IRS treats the money as a gift to the child who used it to pay the debt. As such, a non-dependent child can qualify to deduct up to $2,500 of student-loan interest paid. Be advised, however, that mom and dad can't claim the interest deduction. Legally, it’s not their debt.
Just remember, in order to get the most out of your tax returns, you must stay as organized as possible, and do your research—no one likes getting audited.
Kimberly J. Howard, CFP www.kjhfinancialservices.com
As an advisor, I see it as my role to not only minimize today's tax liability, but to have a game plan for the long-term.
I work with a lot of retirees and savers who did the right thing, saved to pre-tax accounts throughout their careers, and ended up paying MORE in taxes in retirement (or, left these assets to spouses to pay more in tax).
Minimizing current tax liability shouldn't be the only goal of the average investor. It should be looking at your overall exposure to 'tax risk', the risk of possibly paying more down the road.
Things like Roth IRAs, after-tax contributions, conversions to Roth accounts, and saving to taxable accounts can all help mitigate this risk.
What you don't want is to be in retirement, have no control over your tax exposure, and we find our government has turned back tax tables to higher rates, as we have had in the past.
You can minimize tax liability in more ways than can be counted here. You are limited only by your imagination, the creativity of your professional team, and your willingness to go right up to whatever lines the IRS has.
As noted once in a US Supreme Court opinion, tax avoidance is not illegal. Tax evasion is. Being on the right side of the line is key.
For some who have deep pockets and can afford to hire teams of high-priced tax attorneys and accountants, the number of creative ways found to avoid taxes can almost be limitless. But like investing, these kinds of options also come with high risks if the IRS deems the strategies to be illegal or abusive.
For most people without an entourage of professionals, there are still some conventional ways to minimize your tax liability.
The best options usually involve being self-employed or owning rental real estate. For these folks, there is the opportunity to use depreciation, a calculated non-cash expense, to lower one's taxable profits from a business or rental property. Likewise, you can find ways to legally shift income.
One way is to hire family members like a spouse or minor children which shifts net profit from your tax bracket to someone who may be in a no-tax bracket. This works especially well if you help the minor child use his income to fund a Roth IRA which gives him a head start on retirement savings and is a neat way to save for college, too.
Another option is to supplement medical expenses through a Medical Expense Plan sponsored by your enterprise. Let's face it. You were going to incur and pay those expenses anyway, but through these methods you can now get a legal tax subsidy.
For those who are W2 earners, the best options relate to employer-sponsored benefits. Take advantage of any benefit that shifts income to a tax-deferred vehicle. These include employer-sponsored retirement plans, flexible spending accounts for health or dependent care.
If you don't work outside the home, but you have a spouse who does, then be sure to fund your own IRA to the max. This will help your own retirement,t but also reduce your current year taxable income.
If you have deeper financial pockets, you can consider investing in municipal bonds, which produce tax-exempt income, or in partnerships like oil and gas exploration, which produce depreciation and losses that can be used to offset your other income.
To really figure out your best options, you should have a plan. So, you should reach out to a qualified financial professional who knows how to integrate tax planning for your personal situation.