Tax season is right around the corner, and everybody wants the smallest tax bill or the biggest refund possible. Here are three things you can do right now to make sure your 2014 income tax is as low as possible.
Matt Frankel: One of the best ways to legally reduce your income tax is to make sure you're taking advantage of every tax break you are entitled to.
There are plenty of tax breaks that are overlooked by lots of taxpayers every year, and according to this year's list from Intuit's (NASDAQ:INTU) TurboTax, some can potentially be worth a lot of money.
For example, did you know that you can deduct all of the state sales tax you pay throughout the year? And, you don't need to save every single receipt to be able to do it, since the IRS has tables that show you how much to deduct. You can take the larger of state sales taxes or state income tax, so this can literally be worth thousands in states where there is no income tax.
Other commonly overlooked deductions include the "points" you pay when refinancing a mortgage, moving expenses, and out-of-pocket charitable contributions.
There are many books out there full of tax deductions (my personal favorite is J.K. Lasser's version, but there are plenty of good ones out there), so it may be a good idea to invest in one. If the book costs $20 and takes a few hours of your time to skim through, all you would need to find is one additional deduction to make it worthwhile.
Selena Maranjian: One of the best ways to legally reduce your taxes is to contribute to a traditional IRA -- and it isn't too late to do so for the 2014 tax year. The deadline for IRA contributions is the same as the main tax return deadline, which is usually April 15. For 2014 and 2015, most of us can contribute up to $5,500 -- or $6,500 if we're at least 50 years old at some point in the tax year.
Why contribute to a traditional IRA? And why not a Roth IRA? Well, let's review the difference, briefly. With a traditional IRA, you contribute money on a pretax basis, so the value of your contributions is subtracted from your taxable income, thereby reducing the tax you pay now. The money grows tax deferred until you withdraw it in retirement, when it's taxed as ordinary income. The Roth IRA, meanwhile, accepts only posttax contributions, so you get no tax break up front. But if you follow the rules, it's withdrawn in retirement completely tax free.
Clearly, there's a lot to like about the Roth. And for many people, especially those with long investing horizons, it can be the right choice. But the traditional IRA deserves consideration, too. The Roth gives you a deferred tax break, but the traditional gives it to you upfront. If your taxable income is $50,000 and you contribute $5,000 to a traditional IRA, your taxable income falls to $45,000. If you're in the 25% tax bracket, you just saved $1,250. In the 35% bracket, you'd save $1,750. There's another upside to the traditional IRA for many people: When you ultimately withdraw money from it, that money is taxable at your ordinary income rate. For many of us, our tax rates in retirement will be lower than our current tax rates. Thus, not only are we deferring taxation on a sizable chunk of money, we're often setting it up for a lower tax rate, too.
Dan Caplinger: One thing that many people forget at tax time is that if they haven't paid enough of their eventual tax liability to the government -- either through payroll withholding or in estimated tax payments -- then they'll owe interest and penalties when they file their returns. Moreover, those who either don't file on time or don't pay their full tax bill by April 15 risk also will have to pay interest and penalties. So to cut your eventual 2014 tax bill, it's smart to take steps to reduce or eliminate those potential extra charges.
In general, if you don't pay at least 90% of your tax through withholding and estimated tax payments, and your total remaining tax bill is more than $1,000, then you might face a penalty for underpaying estimated tax. Fourth quarter estimated-tax payments are due Jan. 15, and while you might not eliminate your penalty by starting estimated-tax payments so late in the tax year, you can reduce the amount involved. The sooner you pay, the less you'll owe.
Similarly, avoiding filing and payment penalties on your 2014 tax return is vital. The penalty for not filing is 5% of your tax liability per month, while the penalty for not paying is 0.5% per month. So even if you can't pay all your taxes on time, make sure you file your return -- or get an extension -- rather than just not filing at all. That way, your penalty will at least be less than it would have been.