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December 21, 202020 Ways to Reduce Your Taxes
2020 is gone and, for financial planners and tax advisors, that means it’s time to turn our attention to tax season. I know, not the most festive subject, but it is something we all must deal with. So, why not make the best of it by discussing ways to lower your tax liability? Yeah, I thought that might pique your interest a bit. Join me as I reveal 20 ways to reduce your taxes!
Follow Along With The Financially Simple Experience!
TIME INDEX:
- 00:48 – 20 Ways to Reduce Your 2020 Taxes
- 01:46 – Retirement Account Contributions
- 03:09 – Tax-Loss Harvesting
- 03:43 – Tax Bunching
- 05:11 – Health Insurance
- 05:35 – Health Savings Account
- 06:16 – Flexible Spending Account
- 06:41 – Medical Expenses
- 07:16 – Budget Tracking
- 07:57 – Income Adjustments
- 08:45 – Business Deductions
- 09:13 – 529 Plan Contribution
- 09:39 – Lifetime Learning Credit
- 09:56 – Have a Baby
- 10:22 – Give to Charity
- 11:04 – Buy a House
- 11:50 – Property Reassessment
- 12:05 – Improve Home Energy Efficiency
- 12:30 – Buy a Car
- 12:51 – Move to a Lower Income Tax State
- 13:37 – Donor Advised Fund
- 14:27 – Summary
20 Ways to Reduce Your Taxes
Look friends, nobody likes to pay taxes. I mean, what’s worse than working your tail off and then turning around and giving a huge chunk of your earnings to Uncle Sam? But whether or not we like it, it’s a necessary part of life. The good news is there are plenty of legal ways to limit the amount of your hard-earned income that you must give to the government. In fact, I’ve often said that the IRC is the single greatest wealth-building tool that we have in America.
With that in mind, let’s look at 20 ways to reduce your taxes. But first, I want to be absolutely clear that I am not a tax advisor and the purpose of this blog is to educate you on possible options. I am not providing tax advice and you should always seek the advice of a professional tax advisor before employing any of these strategies.
1. Contribute to Your Retirement Accounts
By the year’s end, you must have your contributions to your 401(k) entered in. The rules are a little different for your IRAs, SEP IRAs, and even solo(k)s. But 401(k)s require that you enter all contributions by the end of the year. If you’re below the age of 50, you can contribute a maximum of $19,500 for 2020. However, people over fifty years old can contribute up to $25,500. That’s a pretty nice chunk of change, folks. And the IRS can’t tax it (unless you use the ROTH portion, but I digress)
If you are using a SEP IRA, you can put 20% of your company’s profits into your SEP. SIMPLE plans allow those under 50-years old to contribute $13,500. For those of you using IRAs and ROTH IRAs, you can contribute $6,000 if you’re under the age of 50, and $7,000 if you’re above 50-years old. Different retirement accounts have different rules, but they are a great way to reduce your taxable income while preparing for your eventual retirement.
2. Tax-Loss Harvesting
Tax-loss harvesting is the process of selling securities at a loss in order to offset short-term capital gains. Because short-term capital gains are usually taxed at a higher rate than long-term, sometimes taking a small loss on another position is worth it from a tax standpoint. Once again, this is a strategy that is best discussed with your financial and tax advisors, as each person’s financial circumstances are unique to them.
RELATED CONTENT: 49 Surprising Small Business Tax Write-Offs You Might Be Able to Take
3. Tax Bunching
With this strategy, you’re attempting to maximize your Schedule A deduction. I know, you’re sitting there saying, “Of course, the Schedule A deduction!” Well, let me put it in financially simple terms. The Schedule A deduction is what you are using when you itemize your tax deductions. To do this, you simply fill out Form 1040 or 1040-SR. However, when the Tax Cuts and Jobs Act was passed in 2017, it raised the standard deduction. By raising the standard deduction, it made it where many people could no longer claim the Schedule A deductions. Instead, they just took the standard deduction.
The concept of tax bunching is one where you combine or “bunch” deductions in order to try to get beyond the standard deduction. A good example of this is if you were donating $10,000 to your favorite charity in 2020 and in 2021. You could combine those payments into a single $20,000 deduction for this year and bunch them with your other itemized deductions to maximize your Schedule A deductions.
4. Health Insurance
One of the hot-button issues when Trump first took office was the repeal of the Obama era health insurance mandate. Although Obamacare still exists, President Trump did away with the penalty for not carrying health insurance. However, there are still some states that require their citizens to keep health insurance. By purchasing a healthcare plan or keeping the one you already have, you may be able to actually lower your state taxes.
5. Health Savings Account
Just like pre-taxed retirement accounts, all money that is placed into a health savings account is tax-free. But here’s the real beauty of an HSA. It’s the only account where you can put your money into it, get a tax deduction, watch it grow while it’s in the account (tax-free), and then withdraw it… TAX-FREE! Folks, that’s a winner winner, chicken dinner where I come from. We’re talking about triple tax savings.
Now, there are some limitations involved. As a married couple in 2020, you can deposit up to $7,100. On the other hand, a single person can contribute up to $3,550. So, there are contribution limits with an HSA, but they still provide a huge tax benefit.
6. Flexible Spending Account
If your company is large enough, they might just offer you a flexible spending account. FSAs allow you to put money away in a very similar way to the health savings account. If you have a larger company, you may want to consider setting up an FSA for your employees.
7. Medical Expenses
Although it seems like a no-brainer, you really would be surprised at how many people have no idea how much they spend on medical expenses each year. Keeping track of your medical expenses is an easy way to reduce your taxes. Save your invoices and bills—you should really be doing this with most things anyway—and section them off in your files. Why? Because they can help you with your Schedule A deductions. And folks, medical expenses add up very quickly because they include insurance premiums, doctor visits, surgeries, prescriptions, etc. That could lead to a major reduction of your taxable income.
8. Budget Tracking
This one trips people up a lot of times. You see, I hear from my CPA buddies all the time about the jumbled mess of receipts and invoices that their clients bring in when tax season rolls around. If you have a prepared and organized representation of your annual expenses, it helps your tax preparer to find those strategies that can save you thousands of dollars in taxes. The thing is, people who don’t track their budgets throughout the year never have any type of organized spreadsheets or documents that depict their annual income and expenses.
Therefore, I implore you to begin writing a budget for your household and keeping track of it. Not only will it help you to control where your money is going throughout the year, but it could save you thousands of dollars when the government comes for their cut.
9. Income Adjustments
Income Adjustments typically pertain to business owners and they involve some level of financial planning. There are scenarios when lowering an owner’s income or changing the way that they receive it (from an owner’s draw to a W2 or visa versa) can actually provide significant tax benefits. Once again, there are a lot of things to consider with this tactic and it should only be done with the help of a qualified financial and tax planner. If you make the wrong move, you could face heavy tax penalties.
10. Utilize Business Deductions
Most CPAs know how to save you money on taxes. However, the truly great ones work with you proactively throughout the year to create strategies and plan to maximize your business deductions. I suggest meeting with your CPA each quarter to discuss your strategy and update them on how things are going. The extra time with them can yield big rewards when tax season comes.
We’re halfway through our list of 20 ways to reduce your taxes, but we’ve still got plenty of great information to dig into. So, take some notes on ideas you’d like to discuss with your tax advisor, next time you see them.
11. 529 Plan Contributions
Depending on the state that you live in, you may want to contribute to a 529 plan. Now, these come in two basic varieties, savings and prepaid tuition plans. Both plans are designed to cover education expenses. But the 529 savings plans grow tax-deferred, and withdrawals are tax-free as long as they’re used for qualified education expenses. There are certain states that offer a deduction based on your 529 plan contributions. If you live in one of these states, the 529 plan contribution is another effective way to reduce your taxes.
12. Lifetime Learning Credit
Unlike tax deductions, which lower your taxable income, tax credits actually reduce your taxes, giving you a larger refund. That’s why I love using tax credits whenever possible. The Lifetime Learning Credit is worth up to $2,000 per return and has no limitation in the number of years that it can be used. To qualify, you must have paid tuition to a post-secondary school during the year. You may claim the credit for any post-secondary class that you take, and are not required to be working towards a degree.
13. Have a Baby
If you’re really desperate to reduce your taxes, you can just have a baby. Of course, I’m kidding. You wouldn’t have a baby just to reduce your taxable income. But you do receive a $2,000 tax credit (there’s that beautiful word again) for each qualifying dependent under the age of 17. Once again, this credit is part of the Trump Tax Cuts and Jobs Act of 2017.
14. Give to Charity
Another great way to reduce your taxes is to donate money to your favorite charity. Not only are you helping a cause that you are passionate about, but you’re also receiving a great tax incentive in the process. Tithing to your church or donating to a private school or charitable organization all count as deductible donations, and can be itemized under your Schedule A deductions.
15. Buy a House
Depending on the type of house you purchase, it’s possible to create deductible expenses and depreciation. Those would apply to an investment property such as a duplex or a home that you intend to rent out to generate income. Even if you’re not purchasing investment properties, you can still deduct the interest from your mortgage payments. Likewise, you can deduct state and local taxes, up to $10,000, from your income tax.
16. Have Your Property Reassessed
If you call your local property assessor to come and reassess your property, it’s possible to pay fewer property taxes. Depending on what your property is used for, its size, age, and even architecture, a reassessment could help you to lower your property taxes.
17. Improve Home Energy Efficiency
As governments are growing more and more environmentally conscious, they have incentivized energy efficiency through energy tax credits. Whether you’ve installed a geothermal heat pump, a more energy-efficient water heater, or insulated windows, the energy credit that runs through 2021 offers a tax credit of up to 30% of the installation costs.
18. Buy a Car
This one doesn’t necessarily have to be a vehicle. It could be a piece of equipment that you can get bonus depreciation from. However, there are certain vehicles that you can receive tax credits for when you purchase them. The IRC gives a little more detail on which vehicles qualify and how much of a tax credit each one is worth. But you can earn a tax credit by purchasing certain vehicles.
19. Move to a State with Lower Income Taxes
This may seem a bit drastic, but there are worse reasons to move. In the state of Tennessee, there is no income tax. The states with higher income tax rates are actually experiencing a little bit of an exodus. People are leaving those states and finding homes in states with lower or even no state-level income tax.
20. Donor Advised Fund
The PPP is going to kind of come back on us. As I like to say, it’s going to give us heartburn. If you get it forgiven, there will be some taxes that are owed on the PPP money. One way to offset these taxes is through a donor-advised fund. With these funds, you can name a charity and place a contribution to the fund. The contribution can be invested, it isn’t strictly a donation. In doing this, you receive a Schedule A deduction. Once the money is moved out of the fund and given to the charity, any additional gains are added to the deduction.
Wrapping Up…
So, there you have it, folks. 20 ways to reduce your taxes. Obviously, not all of these will apply to you. But I hope that I’ve at least given you some ideas that you can run by your tax advisor. We work hard for our money and we should be able to keep as much of it as the law allows. That’s why I strongly encourage you to speak with a qualified tax professional. If you don’t already have one, reach out to us. We can recommend some real rockstars in the industry.
Friends, I know life is hard and it can be complicated. But man, life is good. Taxes can be frustrating. But they don’t need to be. With these 20 tips and a rockstar tax advisor, we can make reducing our taxes at least financially simple.
If you have questions about any of the content in today’s blog or if you need a recommendation for a great tax professional, contact us. The Financially Simple team is always here to help!
