The prospect of reading and thinking about taxes may not be that exciting to you, but give it a second thought. The more you know, the less in taxes you may pay, and the more money you can save. Use these 12 smart tax moves to strengthen your current and future financial security.
- Be organized. You don't want to have to hunt for receipts and tax-related documents at the last minute, when you're rushing to prepare your tax return. Aim to be organized throughout the year, perhaps by maintaining a "taxes" folder or shoebox into which you can drop any receipts or other documents that will support your tax return. For example, you may be able to maximize your use of the Child and Dependent Care Credit if you have receipts for when you sent your kids to day camps -- and even if you drop a parent off at an adult day care while you work. Track your spending, too. if you find that you're spending a lot on healthcare, that might mean you'll be able to itemize your deductions.
- Re-assess your filing status. You may, unwittingly, be neglecting to use a filing status that could give you a lower tax bill. The "single" filing status isn't the one to use, for example, if you're a single parent or support a dependent. Instead, the "head of household" status will give you more favorable tax rates and a significantly higher standard deduction. (For the 2016 tax year, for example, the standard deduction for singles and married folks filing separately is $6,300, but it's $9,300 for heads of households.) If you're married, run the numbers to see whether you're better off filing jointly or separately.
- Look into deductions you can take. Each year, see whether it you'll be better off itemizing deductions or taking a standard deduction. There are gobs of deductions available, many of which are not well known. For example, if you're shouldering student loans and paying a lot (or even a little) in interest and your modified adjusted gross income ("MAGI") is below $80,000 (or $160,000 if you're married and filing jointly), you may be able to deduct up to $2,500 for interest payments made on loans for higher education. If you're in the 25% tax bracket, that can be worth $625 to you.
- Consider "bundling" deductions. If you'll be itemizing -- or, especially, if you almost have enough deductions to make itemizing worthwhile -- you may want to "bundle" some expenses. For example, you might front-load some of the donations you'd make to charities in 2018 by making them in late 2017. That way, when bundled with your regular 2017 donations, there will be a bigger sum to claim as a deduction. You might also pay a property tax bill due in January of 2018 in December of 2017, in order for it to count this year. This strategy might help you be able to itemize deductions at least every other year.
- Look into credits you can take. Tax credits shrink your taxable income on a dollar-for-dollar basis and they're available for all kinds of things, such as education expenses, energy-efficient home improvements, the adoption of children, the care of children and dependents, and much more. A particularly valuable credit, if your income is low enough to qualify, is the Earned Income Tax Credit, which might shrink your income by more than $6,000. The Child and Dependent Care Credit offers a credit of up to $3,000 for the care of one eligible dependent and up to $6,000, total, for two or more.
- Contribute to retirement accounts. Even though we're in 2017, it's not too late to make a 2016 contribution to a Roth or traditional IRA if you haven't done so yet. You have until the regular April tax deadline to do so -- just be sure to specify whether the contribution is for 2016 or 2017. For both traditional and Roth IRAs in 2016 and 2017, contribution limits are $5,500 for most people and $6,500 for those 50 and older. (Limits are occasionally increased, to keep up with inflation.) If you're not already contributing to a workplace-sponsored retirement plan such as a 401(k), start soon -- and be aggressive about it, if you can. Here's how much you might amass over time if you can sock away $5,000 or $10,000 each year:
Growing at 8% for
$5,000 invested annually
$10,000 invested annually
- Optimize your retirement accounts. Make sure your retirement money is being invested effectively. Are your balances growing at a good clip? Be sure you've made savvy choices with those accounts. For example, if you're still decades from retirement, it makes sense to be heavily weighted in stocks, not bonds. If you're approaching retirement, you might want more stable stocks and more bonds. If your stocks and/or stock funds aren't growing as briskly as the S&P 500, you'd do better to just stick with S&P 500-based index funds, such as the SPDR S&P 500 ETF (NYSEMKT:SPY). There's no shame in that.
- Keep your holding periods in mind. If you own stocks and you're thinking of selling some in the near future, give taxes a little thought. Don't base your decision solely on taxes, but know that most of us face long-term capital gains tax rates (for qualifying assets that were held at least a year and a day) of 15%. Short-term capital gains face your ordinary income tax rate, which could be close to twice as high. So if you've held a stock you want to sell for 11 months, think about whether you might want to hang on for another month (and a day!).
- Open a Health Savings Account (HSA). If you have a qualifying high-deductible health insurance plan, you may be able to take advantage of HSAs. You fund an HSA with pre-tax money, lowering your tax bill. That money can be used tax-free for qualifying healthcare expenses. The money in the account can accumulate over years, too, invested and growing. Once you turn 65, you can withdraw money from an HSA for any purpose, paying ordinary income tax rates on withdrawals. HSA contribution limits for individuals are $3,350 for 2016 and $3,400 for 2017. For families they're $6,750 for both years. Those 55 or older can chip in an additional $1,000.
- Open a Flexible Spending Account (FSA). This is another account that accepts pre-tax dollars and lets you spend them tax-free on healthcare expenses. It's not quite as wonderful, though, as you need to use most of your contribution each year, or you lose it. Still, if you plan well, this can save you a lot in taxes. If you're expecting to pay $2,000 on braces for your child this year, sock that much into your FSA and you'll avoid paying taxes on it. Contribution limits for Health FSAs are $2,550 for 2016 and $2,600 for 2017.
- Contribute to a 529 plan. 529 plans let you save a lot for college expenses. Money in them grows tax-free and distributions taken to pay for qualified education expenses are not taxed, either. Better still, many states offer tax breaks for their residents who sock money away in the state 529 plan – and some states offer tax breaks for money saved in another state's plan (which might be more attractive than you own state's plans). 529 plans sport generous contribution limits of up to several hundred thousand dollars per beneficiary.
- Hire a tax pro. You might not like the idea of paying someone to help with your tax strategizing and tax-return preparation. The benefit can be well worth the cost, though. A good tax pro will know far more about the tax code than you do and may be able to lower your tax bill while suggesting effective strategies for you. But don't just hire anyone. Ask around for recommendations. Consider hiring an "Enrolled Agent," a tax pro licensed by the IRS who is authorized to represent you before the IRS if need be. You might find one through the National Association of Enrolled Agents website.
The total median income tax paid by American taxpayers was recently $10,116. There's a good chance that your bill tops that each year. If you want to save money and shrink your tax bill, take on a bunch of the actions above. You may well end up keeping thousands of dollars in your pocket and not Uncle Sam's.