Seven Tips You Can Do Now to Cut Next Year’s Tax Bill
By Russell W. Hall, CFP®
If you’re reading this article, it’s very likely that you’ve discovered the truth of that old (and overused) adage about the only certain things in life. Rates may fluctuate up and down, the government may change rules to incentivize or discourage behavior, but one truth remains – taxes aren’t going away! So here are seven tips to potentially help cut your taxes now.
First, a disclaimer: everything we’ll talk about here is legal, and we don’t recommend venturing beyond that. Even in gray areas we usually counsel erring on the safe side. With that said, here are some ideas:
1. Retirement Contributions – If you’re still working, you can increase or even maximize your IRA, 401(k) or other retirement account contributions. This may seem basic to some, but you would be surprised at the number of times we have seen people making lower contributions or none at all, even when there would be a matching contribution from their company. Contributing to a pre-tax retirement account immediately reduces your taxable income, and it helps you save more for retirement too!
2. Health-Savings Account - If your employer offers a health-savings account (HSA) paired with a high-deductible health insurance plan, you may want to take advantage especially if you are in good health. That’s because a HSA can allow for triple-tax-free savings: contributions are tax-deductible, the assets grow without being taxed, and then withdrawals are tax-free if spent for qualified medical expenses. Self-employed people may also be able to open an HSA.
3. Tax-Exempt - If you have taxable investments, look at owning tax-exempt bonds or bond funds (also called municipal or tax-free). Like most things we’re discussing, this isn’t a blanket recommendation but rather something you should consider. Tax-exempt bonds pay a lower rate of interest, but since that income is tax-free at the federal and often state level, it can provide you with a higher level of after-tax return depending on what tax bracket you are in.
4. Charitable Contributions - If you’re retired and taking required minimum distributions (RMDs) from your IRA, you can donate up to $100,000 of that RMD directly to charity. This is called a qualified charitable distribution, and we previously covered it here in greater detail. The bottom line is that it can be a very good way for retirees to reduce taxable income, which may help decrease the taxable percentage of your Social Security. Of course, you can always donate cash or appreciated securities to charity as well, but watch out for the deduction changes that we’ll talk about next.
5. Deductions - Tax law changes in recent years have reduced the appeal of itemizing deductions. This is especially true for those in states with higher tax rates, since the state and local tax deduction has been limited at $10,000. The vast majority of Americans now use the standard deduction, but there’s still a possibility that you could itemize deductions. One way is to “bunch” deductions, where you take the standard deduction one year and then itemize the next. To make that work, you could shift your charitable contributions (non-QCD) to every other year. You could also possibly move around property tax payments, or other deductions like medical expenses if you have flexibility on the timing.
6. Taking Losses – The stock market has had a wild ride this year, but even in relatively calmer times there can be opportunities to take a taxable loss in individual holdings. Losses not only help offset future capital gains, but up to $3,000 per year can also be a deduction against other income (and any amount remaining carries forward to future years). As you sell investments, be sure that you wait a full 31 days to buy any of them back, and avoid buying a replacement investment that is “substantially identical”.
7. Filing Status – This one is a little trickier because it can involve relationships and money. But if you are married and filing separately, it may be a good time to look at the numbers and think about switching to filing jointly. Many tax benefits are limited or cut out when you file separately, so the tax savings of switching to a joint return could outweigh any complications.
One last word of caution – one of our company’s founders always said “Don’t let the tax tail wag the dog.” In other words, don’t only do something to save taxes when it will ultimately cost you more money. For example, giving money to charity is an excellent thing to do if you have charitable intent, but if you’re only doing it to save on taxes, you’re essentially giving away one dollar to save thirty cents or less.
At our Fullerton financial advisory firm, we don’t prepare tax returns but do have extensive knowledge of taxes and often assist our clients in this area. Schedule a 15-minute discovery call with a fee-only financial advisor.