If you think you're done with taxes now and can enjoy not thinking about them until March or April of 2017, think again. To minimize your tax bill next year, there are some smart moves you can make now and in the months ahead. Savvy tax planning doesn't have to take a lot of time, but it's a year-round undertaking. Here are five money-saving tax tips to put to use this summer.
One of the smartest ways to lower your tax bill is to put more money into your tax-deferred retirement accounts, such as traditional IRAs and 401(k) accounts. Since pre-tax money is used to fund these accounts, adding more money now will lower your total taxable income and lead you to pay out less in income taxes next year.
There could be other benefits to increasing your retirement contributions, too. That's especially true if your employer offers a matching contribution to your 401(k) and you are not yet contributing enough to take full advantage of that. As an example, if your company provides a 50% match on the first 6% of your salary, and you are not yet contributing 6%, then you are saying no to free money. Bumping your contribution rate up to that 6% will not only provide you with an immediate 50% return from your employer, but it will also lower your tax bill. That's a huge win!
If you're worried that can't afford an increase, then I'd still advise you to go for it, but start out small. Simply add an extra 1% of your salary to a tax-deferred plan right now and judge for yourself how it goes. My hunch is that after a few paychecks, you'll hardly notice the difference. If so, then add another 1% a few months down the road, and repeat that process as many times as possible. Do that enough times, and you'll be at the maximum level, turning you into a retirement rock star.
The phrase "spring cleaning" isn't exactly music to homeowners' ears. Yet this tiresome annual ritual can turn into a tax-saving venture.
For years, my wife and I have been trying to pare down our possessions. They clog up our living space and create mental clutter that stresses us out. There are usually many trips to Goodwill involved in this process. But whenever tax time rolled around, I was unable to claim a tax break for the things we donated because I didn't keep clean records.
That changed this year. TurboTax has a handy tool that has made the process much easier. Using the company's ItsDeductible tool, I take a brief survey of what we're donating each week. The tool has acceptable estimates for each item's value, and it keeps a log of everything that's been donated. In total, it takes just five minutes each week. And when the time comes to file my tax return, the deductions are seamlessly added to my tax return, because I also use TurboTax to file.
While we prefer ItsDeductible, know that it's not the only tool that can help you track your charitable donations. H&R Block, for example, has a similar tool called DeductionPro. Do a bit of shopping and decide which offering makes sense for you. By the way: Most of these programs, including ItsDeductible and DeductionPro, are 100% free to use.
If you're a parent and an entrepreneur, then there's a smart way you can not only reduce your taxable income, but also give your kids a way to earn money and learn the value of hard work: employ them. If you happen to own your own business, you can hire your children under the age of 18 and then deduct the wages you pay them from your own taxable income. Additionally, if you operate a sole proprietorship, you can even employ your children without having to pay Social Security taxes or Medicare taxes on their wages.
What's the catch to this great tax deduction? Namely, you'll want to ensure you're paying your kids under the age of 18 a reasonable wage based on the work they're performing. Otherwise you could raise a red flag that triggers a tax audit -- and no one wants that.
Additionally, give serious consideration to reviewing your withholding status on your W-4 at least once per quarter. With half the year having passed, summer is often a great time to assess how much you've paid in federal income taxes so far, compared to what you expect to earn for the full year. Since most taxpayers wind up netting a refund come tax time, chances are that you've overpaid what you'll likely owe. This means the government is keeping your money for the next few months to a year without giving you a red cent in interest. If you adjust your tax withholding on your W-4, then you may be able to put more money into your pocket with each paycheck for the remainder of the year and put that money to work immediately, not months from now.
You could save thousands of dollars off your utility bills over the next couple of decades by installing a solar energy system. And with the recently extended solar investment tax credit covering 30% of the cost of the system and installation, it's probably more affordable than you think. There are also ways to reduce or even eliminate the up-front cost, too.
Between low- or even no-money-down loans, along with solar system lease and power purchase agreements (usually called PPAs), you can sign up for 20 years of low-cost solar and pass on the tax credit to the installer or lender you work with. Meanwhile, you get the benefit of a lower monthly bill for the next 20 years.
Going solar isn't the only way to save money on your utilities while also getting a tax break. The Nonbusiness Energy Property Credit can get you up to 10% back if you make certain energy-efficient home improvements. These include insulation, high-efficiency water heaters, heating and air-conditioning systems, and external windows. Not only will these improvements help you save money on your utility bills, but a tax credit for 10% of the cost can make it an easier decision.
Keep in mind that this tax credit has a lifetime cap of $500 and is set to expire at the end of 2016.
A final way you might shrink your tax bill this year is by opening a Flexible Spending Account (FSA) if you're able. These plans are typically offered by employers, with contributions coming out of your paycheck on a pre-tax basis. (That means you're not taxed on them.) For 2016, the limit is $2,550. If you're in the 25% tax bracket and can shrink your taxable income by $2,550, you'll avoid paying nearly $640 in taxes.
There are several varieties of FSAs. A healthcare FSA (not to be confused with a Health Savings Account, or HSA) lets you sock money away for healthcare expenses, while others focus on dependent care expenses (such as day care) or adoption expenses or health insurance premiums. With a healthcare FSA, the money you contribute to the account can be used tax-free on qualifying healthcare expenses, such as: birth control pills, breast pumps, chiropractor services, dental work, drugs, eyeglasses, fertility treatment, hearing aids, optometrist services, psychiatric care, smoking cessation programs, some weight-loss programs, wheelchairs, wigs, X-rays, and more. Expenses that miss the mark include cosmetic surgery, diapers, gym memberships, electrolysis, many nonprescription drugs, nutritional supplements, teeth whitening, and veterinary services.
An FSA has a significant drawback, though: It's use-it-or-lose-it with the money you contribute each year. The rules were recently relaxed just a little so that now your employer may choose to extend the spending deadline by up to 2-1/2 months or permit you to carry over up to $500 to spend in the following year. It might not offer either option, though, so learn the rules for your particular account. Also, you generally have to set up an FSA during your employer's open enrollment period, so find out when that is.
Take some action now and you can save hundreds or thousands of dollars in taxes.