How to Lower Your Tax Burden
How to Lower Your Tax Burden
Paying taxes usually isn't high on people's lists of things they like to do, but it's the law. But you can take steps to lower your tax burden. Many techniques require some planning, so the earlier you start thinking about your tax bill, the more opportunities you'll have to lower it.
Contribute to Pretax Retirement Accounts
Contributing to a traditional 401(k) or 403(b) plan reduces your tax burden by deferring or setting aside the income you contribute. For example, if your salary is $65,000 but you tell your employer to withhold $5,000 for your 401(k), you're only taxed on $60,000 of income.
If you're not covered by an employer's retirement plan, you can contribute to a traditional IRA and use the contribution to reduce your taxable income, even if you don't itemize. This is one of the few deductions you can take advantage of after the end of the year: You can deduct contributions as late as your tax filing deadline for the prior year, not including extensions. Just make sure you indicate which tax year you want your contributions counted toward when you make them.
Use Tax-Advantaged Accounts for Healthcare
Many employers offer flexible spending accounts, or FSAs, that allow you to set aside money for medical expenses during the year. As of 2015, you can choose to contribute up to $2,550 with no eligibility requirements, and your contributions aren't included in your taxable income. Just note that you lose any portion you don't spend by the end of the year.
If you have a high-deductible health insurance policy, you can contribute to a Health Savings Account, or HSA, instead. These are even better than FSAs because they have a higher contribution limit of $3,350 for individuals and $6,650 for families as of 2015.
You can adjust your contributions throughout the year and rollover any unused balance to the next year. There's no risk that if you contribute too much, you'll lose it at the end of the year.
Check Your Itemized Deduction Total
You have the option to reduce your taxable income every year by using either the standard deduction or the total of your itemized deductions. Although checking the "standard deduction" box might be faster, you may leave money on the table. Big-ticket itemized deductions include state and local taxes — either income or sales taxes — as well as real estate taxes, mortgage interest and charitable contributions.
If you want to go a step further, try to cluster as many itemized deduction expenses in the same calendar year as possible, such as charitable expenses. You can switch back and forth between itemizing and claiming the standard deduction from year to year so you can itemize when you make larger charitable contributions and then take the standard deduction in the other years.
Manage Your Investments
When you're selling investments, you might not think too much about how long you've owned them, but it could make a big difference in how much of your profits you must share with the IRS.
If you sell investments you've owned for up to one year, they're taxed at ordinary income rates, which max out at 39.6 percent. But if you hold an investment for more than one year, your profits are taxed at the lower long-term capital gains rates, which top out at just 20 percent.
If you're concerned about your federal tax rate, consider adding municipal bonds to your portfolio because the interest isn't subject to federal income taxes. The trade-off is that these investments often carry a lower interest rate to begin with, so they don't make sense for everyone.
- IRS: Retirement Topics -- Contributions
- IRS: Publication 590-A
- Forbes: My Employer Offers Both HSA and FSA. What's the Difference, and Which Should I Use?
- IRS: Itemizing vs. Standard Deduction: Six Tips to Help You Choose
- IRS: Topic 409 - Capital Gains and Losses
- Schwab: Municipal Bonds: When Tax-Free Isn't So Free