26 Jan Jonathan Cartu Divulges: 18 Ways to Reduce Your Taxes
Death and taxes may be two certainties few people look forward to, but there’s another, rosier certainty — that many ways to shrink your tax bill exist, and most of us can take advantage of at least a few, in order to lop hundreds, if not thousands, off our tax bills each year.
Here’s a look at 18 key ways that you may be able to reduce your taxes. See how many you can act on, now or soon, in order to keep more of your money in your pocket.
- Get organized.
- Claim all the tax deductions you can.
- Claim all the tax credits you can.
- Donate money, goods or stock to charity.
- Contribute to a retirement account.
- Use a Flexible Spending Account (FSA).
- Use a Health Savings Account (HSA).
- Contribute to a 529 plan.
- Offset capital gains with capital losses.
- Hold on to investments longer.
- Time your mutual fund investments.
- Buy a home with a mortgage.
- Be strategic when selling your home.
- Use the right filing status.
- Keep up with changes in the tax code.
- Employ a tax-friendly Social Security strategy.
- Use tax-prep software.
- Get help from a tax pro.
1. Get organized.
First up, be organized. Don’t just deal with your taxes once a year, in April. Instead, dedicate a folder or box to tax-related documents, and fill it all year long — with receipts for deductible expenses, 1099 forms and other IRS forms that arrive in the mail, trade confirmations and end-of-year statements from bank and investment accounts that you may need to refer to, and so on. That way, when it’s time to start preparing your tax return — or to hand off needed information to a paid preparer — everything will already be in one place.
Keep your tax-related records for a while, too. It’s smart to keep copies of your returns, at least for a minimum of three years and, to be more conservative, up to seven. You’ll likely be free from any chance of a tax audit by then.
2. Claim all the deductions you can.
As you know, a tax deduction shrinks your tax bill by shrinking your taxable income. If, for example, you earn $70,000 and take a $5,000 deduction, your taxable income will shrink by $5,000, letting you avoid being taxed on that $5,000. If you’re in a 24% tax bracket, that could save you $1,200.
It’s a little more complicated than that, though. You can choose to itemize and claim all your various deductions, or you can just take the “standard deduction” available to all taxpayers. That deduction has been roughly doubled in recent years, making it the smart (and easy!) move for most taxpayers.
Standard Deduction for 2020 Tax Year
Head of Household
Married Filing Jointly
Married Filing Separately
Here are a few things you need to know about deductions:
- There are lots of tax deductions out there. You may qualify for more than you think. There are deductions for expenses ranging from charitable contributions to medical expenses to the sale of your home to retirement account contributions and to bad debt, among many others. (The IRS has a more comprehensive list of tax deductions, and this 2019 review of deductions is also rather thorough.)
- You can take some deductions even if you don’t itemize. Those include deductions for contributions to retirement accounts like an IRA, contributions to Health Savings Accounts (HSAs), alimony from a divorce, student loan interest, and self-employment taxes.
- Some well-known and commonly used deductions have gone away. The Tax Cuts and Jobs Act of 2017 eliminated some tax deductions, such as the miscellaneous deduction (which included job-search fees and tax-preparation fees), and the deduction for moving expenses (for most people, but not military folks).
- If you don’t have quite enough deductions to make itemizing worthwhile, you might do well to “bundle” some deductions by moving up some expenses you’d pay next year, paying them late this year. For example, you could make an extra mortgage payment, which would increase your mortgage interest paid this year, and if you donate a lot to charity each year, you might make next year’s contributions at the end of this year. By moving around some flexible expenditures, you may be able to itemize deductions one year and then take the standard deduction the following year, and perhaps keep alternating like that.
3. Claim all the tax credits you can.
It’s important to make the most of not just tax deductions, but also tax credits. Credits, after all, are far more valuable than deductions. Remember how a $5,000 deduction might shrink your tax bill by 24% or $1,200? A $5,000 credit can shrink it by $5,000.
The most powerful tax credits are “refundable” ones, meaning that you get their full value even if they shrink your tax bill to less than zero. For example, imagine that you’re on track to owe $4,000 in taxes but you then apply a $5,000 tax credit. If it’s an ordinary credit, it will wipe out all of the $4,000 you owe, and will stop there. A refundable credit, though, will wipe out the $4,000 and then still give you that last $1,000 of value — via a tax refund.
There are lots of tax credits available, relating to expenses for education, the adoption of a child, dependent care, energy-efficient home improvements, and more.
4. Donate money, goods, or stock to charity.
As mentioned earlier, you can take a tax deduction for donations to qualifying charitable organizations — and that includes donations made in the form of cash, stocks, goods, and even miles driven.
There are a bunch of rules regarding charitable donations you need to know about, though, such as:
- The non-profit organization must qualify for charitable status under Section 501(c)(3) of the Internal Revenue Code. That generally rules out political organizations, fraternities, and social and business clubs. (Most GoFundMe contributions also don’t qualify, as they’re technically personal gifts, but those made to a “GoFundMe Certified Charity” do qualify. You can look up whether an organization is tax-exempt at the IRS website, and alternatively, you can ask the organization itself. It may have a “determination letter” stating that it has qualified for tax-exempt status that it can show you.
- Save your receipts! If you’re donating $250 or more in cash or goods, the IRS requires “a bank record, payroll deduction records or a written acknowledgment from the qualified organization showing the amount of the cash and a description of any property contributed, and whether the organization provided any goods or services in exchange for the gift.” (That’s because if you donated $50 to an organization and got a t-shirt valued at $10 in return, you can only deduct $40.)
- Non-cash donations totaling more than $500 will require that you fill out and include Form 8283 with your return.
- When donating goods, know that you can generally only deduct their fair market value, not their value when originally purchased. Large charities such as Goodwill and the Salvation Army have donation value guides online, where you can look up values you can claim. A business suit in good condition may only result in a $12 deduction, for example, while a bicycle may only get you $10. But added together, many items can easily get you hundreds of dollars in deductions.
- There are special rules governing the donation of cars to charities. For example, the IRS states that, “Charities typically sell the vehicles that are donated to them. If the charity sells the vehicle, generally your deduction is limited to the gross proceeds from the sale.” (Of course, there are exceptions to that rule, too.)
5. Contribute to a retirement account.
Tax breaks are available to you if you contribute to retirement accounts such as IRAs and 401(k)s, but it depends on whether you contribute to a “traditional” or “Roth” version of the account. Contributions to Roth accounts give you no upfront deduction, but if…