The way to lower your tax bill is to lower your taxable income. Lowering your taxable income is not the same as lowering your gross income. The goal is to maximize your gross income but minimize your taxable income and to achieve that goal you will need to itemize as much as possible.
Deduct Medical Expenses
When medical and dental expenses exceed more than 10% of your adjusted gross income, they may generally be deducted. This 10% threshold applies to all individuals, including seniors over the age of 65.
The way it works is anything over the threshold may be deducted. If you earn say $60,000 then any medical expenses over $6,000 (10% of $60,000) may be deducted. So if you had $8,000 in medical costs, $2,000 could be deducted.
Deduct Investment Losses
If your portfolio holds winning investments that you sold for a profit during the year, other losing investments may be sold to offset capital gains tax. Selling investments for tax reasons alone is generally not a wise strategy and the IRS can effectively void your tax break if you buy the position again within 30 days; this is called a wash-sale.
The limit imposed by the IRS on offsetting capital gains taxes is $1,500 for married couples filing separately or $3,000 otherwise.
Pay Mortgage Interest Early
Mortgage interest counts as a deduction on your taxes. Most people follow a regular monthly schedule of paying off their mortgages so their annual mortgage interest deductions are the sum of interest payments made over 12 months. Generally, you are permitted to accelerate your mortgage payments without penalty. So if you are looking to minimize taxable income for the year, you could consider paying your mortgage interest for January of the following year in December of the prior year to get an extra month’s interest deduction.
Other qualifying expenses that may be predictable and which you can afford to pay off before year end will count as deductions too and lower your tax bill.
Maximize IRA Contributions
As an individual, you may contribute as much as $5,500 annually to a traditional IRA or $6,500 if over the age of 50. Contributions can be made all the way up to the April tax deadline and still count for the prior year.
The amount of the IRA contribution that may be deducted depends on:
- Income earned
- Work retirement plan coverage
If you are covered by a work retirement plan you may be prohibited from deducting IRA contributions.
Maximize 401(k) Contributions
Although 401(k)s are typically sponsored by employers, self-employed individuals may also contribute to a 401(k) plan up to $18,000 annually for those under 50 and up to $24,000 annually for those aged 50 and above.
Employer contribution matching to your 401(k) plan is quite common and accelerates your retirement goals.
Donate to Charity
Good tax software is available these days to sum the deductions you take for donating cash or goods, such as food and clothes, to charity.
If you help out at the local soup kitchen, your travel expenses and mileage are deductible.
Raise Your W-4 Withholding
When you start a job, you will typically select how much tax you want your employer to withhold from your salary. The W-4 selections can be changed at any time and optimized as follows:
- If your tax bill was larger than you wanted, increase your withholding in order to pay less in the future.
- If you received a refund, reduce your withholding so the government doesn’t get a free lunch on your dime.
Make 529 Plan Contributions
States and educational institutions operate 529 savings plans to allow parents save up to $14,000 annually for each child’s college tuition and enjoy a tax break in the process. Contributions greater than $14,000 can trigger a gift tax so consult a tax preparer if you are uncertain whether you are at risk of exceeding the threshold.
If you contribute to a 529 Plan operated by your state, you can typically deduct 529 Plan contributions on your state taxes as well as your federal taxes.