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3 Smart Tax Moves

By Selena Maranjian - Jun 18, 2017 at 7:42AM

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Make taxes less boring and more exciting by learning how you can shave thousands of dollars off your tax bill. See which of these smart tax moves you can employ -- there's a good chance all three could help you.

"Death, taxes, and childbirth! There's never any convenient time for any of them."
-- Margaret Mitchell 

Taxes are unavoidable, but they're not unmanageable. If you take some time to learn more about them, you may be able to make some smart tax moves that can save you hundreds or thousands of dollars. Here are three powerful things you can do to shrink your tax bill and keep more money in your pocket.

A jigsaw piece is removed from a puzzle to reveal a $100 bill underneath.

Image source: Getty Images.

Smart tax move No. 1: Make use of tax-advantaged retirement funds

It's up to most of us to provide much of the income we'll need in retirement. An IRA, perhaps in tandem with a 401(k) account, can be a big help in saving for retirement. Let's review both of these options.

There are two main kinds of IRA -- the Roth IRA and the traditional IRA. With a traditional IRA, you contribute pre-tax money that reduces your taxable income and, therefore, your tax bill for the year. If your income is $75,000 and you contribute $10,000 to a traditional IRA and/or a 401(k), your taxable income drops to $65,000, letting you postpone being taxed on $10,000. When you withdraw the money in retirement, it's taxed as ordinary income to you for that year. With the Roth IRA, you contribute post-tax money that doesn't deliver any upfront tax break. But you eventually get a big tax break when you withdraw from the account in retirement – because if you follow the rules, you get to take all the money out of the account tax-free. It's pretty much the same with 401(k) and their newer counterpart, the Roth 401(k).

For both traditional and Roth IRAs in 2017, the contribution limit is $5,500 for most people and $6,500 for those 50 and older. (Limits are occasionally increased, to keep up with inflation.) That might not seem like a lot of money, but it's quite powerful if it can grow for many years. The following table shows how much money you can accumulate with annual $5,500 contributions at different average annual rates of growth:

$5,500 Invested Annually For:

Growing at 6%

Growing at 8%

Growing at 10%

15 years

$135,699

$161,284

$199,224

20 years

$214460

$271,826

$346,514

25 years

$319,860

$434,249

$595,000

30 years

$460,909

$672,902

$995,189

Data source: calculations by author.

A 401(k) plan, meanwhile, can be even more powerful and will typically feature free money from your employer, in the form of matching funds. The contribution limit for 401(k) accounts is generous: For 2017, you can contribute up to $18,000 to your 401(k), plus an additional $6,000 if you're 50 or older -- for a possible total of $24,000! The following table shows how effective it is to make big annual contributions and to do so for as many years as possible.

Growing at 8% For:

$10,000 Invested Annually

$15,000 Invested Annually

$18,000 Invested Annually

10 years

$156,455

$234,682

$281,619

15 years

$293,243

$439,864

$527,837

20 years

$494,229

$741,344

$889,613

25 years

$789,544

$1.2 million

$1.4 million

30 years

$1.2 million

$1.8 million

$2.2 million

Data source: calculations by author.

Finally, if you have a qualifying high-deductible health insurance plan, you may be able to take advantage of a Health Savings Account (HSA). 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 -- and making the account serve as an additional retirement savings account. HSA contribution limits for 2017 are $3,400 for individuals and $6,750 for families. Those 55 or older can chip in an additional $1,000.

"how much can you save?" circled in red by a hand

Image source: Getty Images.

Smart tax move No. 2: Look into deductions and credits you can take

It's a shame any time someone doesn't take advantage of available tax deductions. There are gobs of deductions one might take, but many are not well known. Most people know that charitable contributions can be deductible, as can medical expenses, if they exceed a certain amount. But did you know that you may be able to claim a deduction for student-loan interest you pay or moving expenses you incur when moving for a new job or money you spend as a teacher supplying your classroom? Even gambling losses, tax-prep fees, and union dues can be deductible. (All of these have rules and restrictions, so look more closely at any for which you might qualify.)

There are many available tax credits, too, and they're much more powerful than tax deductions. Have taxable income of $75,000 and $5,000 in deductions? Your taxable income is now $70,000. If you're in the 25% tax bracket, you avoid being taxed on that $5,000 and save $1,250. But if you have taxable income of $75,000 and a $5,000 tax credit, the credit reduces your tax dollar-for-dollar. It's worth a full $5,000.

Tax credits shrink are 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. And the Child Tax Credit offers $1,000 for every eligible child you have who is under the age of 17 (as of the end of the tax year) -- subject to some rules and restrictions again, of course.

"Keep more of your money" is written on a chalkboard, with a pen, calculator, glasses, graphs, and binders surrounding it.

Image source: Getty Images.

Smart tax move No. 3: Be tax-smart with your investments

Finally, be smart as you go about your investments, too. For example, if you're thinking about selling some stocks, check how long you've held them. Don't base your selling 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, consider hanging on for another month (and a day!).

You can even be smart when it comes to investment blunders that lost you money. If you know you'll be facing taxes on capital gains you realized throughout the year, such as via stocks sold at a profit, you may be able to reduce or wipe out those taxes by offsetting the gains with losses. For example, if you have $6,000 in gains and you sell enough underwater holdings to generate a loss of $5,000, you can pay taxes only on the net gain of $1,000. If you have way more losses than gains, you can wipe out your gains entirely, then shrink your taxable income with up to $3,000 of your losses -- and then carry over any leftover losses into the next year. Losses can sting, but they do offer a silver lining. (If you plan to buy back any of the losers you sold, be sure to wait at least 31 days, lest you end up with a "wash sale" that doesn't count.)

Here's one more bonus smart tax move: Consider hiring a tax pro. You might want to pay someone to help with your tax strategizing and tax-return preparation, but that money spent can be well worth it. 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 professional 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 tax tips above could save you thousands of dollars, so do spend some time looking into which of them might be smart moves for you. Taxes may seem boring, but the idea of keeping thousands of dollars in your own pocket instead of Uncle Sam's should be rather exciting.

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