There are good and bad ways to cut your tax bill. One bad way is earning less money and another is losing money, such as due to a bunch of stocks that went south. If you want to fork over less money to Uncle Sam, there are better ways to do so. Read on, for three other (and better) ways to cut your tax bill.
Take advantage of credits and deductions
It's perhaps obvious that you can significantly cut your tax bill by taking advantage of available credits and deductions. The problem, though, is that lots of people are unaware of many of them.
It's also important to appreciate the difference between a tax deduction and a tax credit. A deduction lets you reduce your taxable income. Have taxable income of $60,000 and a $4,000 deduction? Your taxable income is now $56,000. If you're in the 25% tax bracket, you avoid being taxed on that $4,000 and save $1,000. If you have taxable income of $60,000 and a $4,000 tax credit, the credit reduces your tax dollar-for-dollar. It's worth a full $4,000.
So what are the credits and deductions available to you? The list is long. Here are a bunch of deductions -- see how many you know about and which ones might apply to you:
- Mortgage interest.
- Points paid when getting a mortgage.
- Medical expenses.
- Job-search expenses.
- Moving expenses (when related to a qualifying job change).
- Educator expenses.
- Student loan interest.
- Tuition and fees at a postsecondary school.
- Charitable contributions.
- Contributions to qualifying retirement accounts.
- Health insurance premiums (for the self-employed).
- State, local, and foreign income taxes and personal property taxes.
- Tax preparation fees.
- Home office expenses.
- Business expenses.
And then there are the even more appealing tax credits you can consider. Some biggies include:
- The Earned Income Tax Credit: This is potentially worth $6,000 or more to low-income folks.
- The Saver's Credit: This is worth up to $1,000 for those with modest incomes.
- The American Opportunity Credit: This is worth up to $2,500 for qualifying postsecondary school expenses.
- The Lifetime Learning Credit: This is worth up to $2,000 for qualifying postsecondary school expenses and even coursework you take on later in life to improve or develop work skills.
- The Residential Energy Efficient Property Credit: This is available through 2016 and offers a credit worth 30% of the cost of alternative energy equipment installed on or in your home, such as solar hot water heaters, solar electric equipment, wind turbines, and fuel cell property.
- The Nonbusiness Energy Property Credit: This offers a credit of 10% of the cost of qualifying energy-efficient home improvements, such as energy-efficient windows and doors, adding insulation to a home, and so on. There's a lifetime limit of $500 for it.
- The Adoption Credit: This offers up to $13,400 in credits related to the adoption of a child, depending on your income.
- The Child Tax Credit: This offers $1,000 for every eligible child you have under the age of 17 (as of the end of the tax year).
- The Child and Dependent Care Credit: This is worth up to $3,000 for a single child or $6,000 for two or more children, and is tied to expenses you incur for the care of children or dependents that lets you work or seek work.
Employ some tax-smart strategies
You can also cut your tax bill by using some strategies. Here are some examples:
- You might combine a business trip with a vacation. That way, you may be able to legitimately deduct part of the costs as business expenses. (If you were at your hotel for four days and spent two days on business, you might deduct the cost of two nights.)
- If you're planning to sell a bunch of stocks and will realize significant capital gains on which you'll be taxed, you can offset some of the gains with losses by selling some underwater holdings.
- If you're planning to sell some stocks that you've held for a year or less to reap gains, think about hanging onto them until you've held them for more than a year. That way the gains will qualify for the lower long-term capital gains tax rate. (Don't do this if the stocks are likely to fall in value, though.)
- If you have a high-deductible health insurance plan, you may be able to contribute to a Health Savings Account, reducing your taxable income and having tax-free funds with which to pay for qualifying healthcare expenses.
- If you're not yet contributing to an IRA and/or 401(k) plan, consider doing so, as that can deliver significant tax breaks. A traditional IRA or 401(k) will reduce your taxable income in the contribution year, whereas a Roth IRA or 401(k) can deliver tax-free withdrawals in retirement.
- If you're expecting a bonus from your employer near the end of the year, perhaps see if it can be postponed, so that it's paid in January instead. Then it will not increase your taxable income for the current year.
Hire a good tax professional
If all this is making your head spin, the last way to cut your tax bill might be a particularly appealing one: Hire a tax pro. A good one will likely be able to save you money because he or she will be familiar with all the available deductions and credits, and because the tax pro will be able to recommend money-saving strategies, too. An extra bonus -- the fee you pay a tax pro is deductible!
Don't just hire anyone or go to a random tax-preparer, though. Ask around for recommendations. Enrolled agents are good bets. They're tax professionals licensed by the IRS -- and you might find one through the National Association of Enrolled Agents website. Or find a certified public accountant through your state's CPA society or state board of accountancy.
There are lots of ways to cut your tax bill. Spending a little time looking into it can save you hundreds or thousands of dollars.