Reducing Your Tax Liability
As we have stated over the years, there is no simple formula for reducing or trimming your tax liability, however, here are a few steps:
#1: Give yourself a raise today: If you received a large tax refund this year, it meant that you're having too much tax taken out of your paycheck and that you are giving the Federal government an interest free loan. During 2012, the average American received a refund of $2,800.00. One should consider evaluating the need for such refunds and consider trying to limit the amount of their refund. For example, based on the average American refund, you would receive an additional $225 monthly.
Action item: File a new W-4 form with your employer (talk to your payroll office) to insure that you get more of your money when you earn it.
#2: Consider an Employer Health Savings Account: If your employer offers a medical reimbursement account, sometimes called a flexible Medical plan, consider enrolling as these plans let you divert part of your salary to an account which you can then tap into to pay unreimbursed medical bills.
Action item: Beginning in 2013, the maximum you can contribute to a health care flex plan is $2,500.
#3: Life changing events - medical reimbursement: If you get married, divorced, or have or adopt a child during 2013, you can change the amount you're setting aside in a medical reimbursement plan.
Action Item: If you anticipate more medical bills, steer more pretax money into the account; if you anticipate fewer, you can pull back on your contributions so you don't have to worry about the use-it-or-lose-it rule.
#4: Day Care - pre-tax dollars: Day care is expensive; therefore $3,000.00 tax savings annually can be very beneficial to you and your family through the use of pre-tax dollars. After taxes, it can easily take $7,500 or more of salary to pay $5,000 worth of child care expenses. But, if you use a child-care reimbursement account at work to pay those bills, you get to use pre-tax dollars. That can save you one-third or more of the cost, since you avoid both income and Social Security taxes.
Action item: Investigate Dependent Care Savings Account from your employer.
#5: Explore a Roth 401(k): If you are concerned about skyrocketing taxes in the future, or if you just want to diversify your taxable income in retirement, considering shifting your retirement plan contributions to a Roth 401(k) if your employer offers one.
#6: Self-employed retirement account: If you are self-employed, you have several choices of tax-favored retirement accounts, including Keogh plans, Simplified Employee Pensions (SEPs) and individual 401(k)s. Contributions cut your tax bill now while earnings grow tax-deferred for your retirement.
#7: Hire your children: If you have an unincorporated business, hiring your children can have real tax advantages. You can deduct what you pay them, thus shifting income from your tax bracket to theirs. Because wages are earned income, the "kiddie tax" does not apply. And, if the child is under age 18, he or she does not have to pay Social Security tax on the earnings. One more advantage: the earnings can serve as a basis for an IRA contribution.
#8: Pay back a 401(k) loan before leaving your job: Failing to do so means the loan amount against your 401(k) will be considered a distribution that will be taxed in your top bracket and, if you're younger than 55 in the year you leave your job, you will be hit with a 10% penalty too.
#9: Improve yourself: Companies offer employees up to $5,250 of educational assistance tax-free each year. Education doesn't have to be job-related and graduate-level even courses qualify.
#10: Moving for a new job: You can deduct the cost of the move if your new job is at least 50 miles farther from your old home than your old job was.
#11: Review job-hunting expenses: Being part of the millions of Americans who are currently unemployed, keep track of your job-hunting costs. As long as you're looking for a new position in the same line of work (your first job doesn't qualify), you can deduct job-hunting costs including travel expenses such as the cost of food, lodging and transportation, if your search takes you away from home overnight.
#12: Roth to save for your first home: Sure, the "R" in IRA stands for retirement, but a Roth IRA can be a powerful tool when you're saving for your first home. All contributions can come out of a Roth at any time, tax- and penalty-free. And, after the account has been opened for five years, up to $10,000 of earnings can be withdrawn tax- and penalty-free for the purchase of your first home
#13: Let Uncle Sam help pay for your home: Purchasing a new home, whether it's your first or a trade-up, usually means a larger mortgage and higher property taxes, which ultimately means a greater deduction for mortgage interest.
Action Item: Consider adjusting your tax withholding from your salary to account for the new tax breaks, and increase your take-home pay.
#14: Saving for college: Stashing money in a custodial account exposes you to the expensive "kiddie tax" rules and gives full control of the account to your child when he or she turns 18 or 21.
Action Item: Using a state-sponsored 529 College Savings Plan can make earnings completely tax free and lets you keep control over the money. If one child decides not to go to college, you can switch the account to another child or take it back.
#15: Deduct expenses even when you take standard deduction: Taxpayers who claim the standard deduction often complain that itemizers get larger tax savings. Fortunately, you can deduct student loan interest, job-related moving expenses, costs incurred by reservists, and performing artists and contributions to health savings accounts and IRAs.
#16: Don't buy a tax bill: Before you invest in a mutual fund at the end of the year, make sure that you know when the fund will distribute dividends. On that day the dividends are distributed, the value of shares will fall by the amount paid. If you buy just before the payout, the dividend will effectively rebate part of your purchase price, but you'll owe tax on the amount.
Action item: Buy mutual funds after the dividend payout - you'll get a lower price and no tax bill.
#17: IRS and your divorce: When working toward an equitable property settlement, watch the tax basis in your investments and the implications of such - that is, the value from which gains or losses will be determined when property is sold. One $100,000 asset might be worth a lot more - or a lot less - than another, after the IRS gets its share. Alimony is deductible by the payer and taxable income to the recipient; a property settlement is neither deductible nor taxable.
#18: Make your IRA contributions sooner rather than later: The earlier in the year your money is in the account, the sooner it begins to earn tax-deferred or, if you use a Roth IRA, tax-free returns.
#19: Children as dependants: A child born, or adopted, during the year is a blessed event for your tax return. An added dependency exemption will knock $3,900 off your taxable income, and you'll probably qualify for the $1,000 child credit, too.
Action item: Don't wait to file your 2013 return to reap the benefit. Add at least one extra withholding allowance to the W-4 form filed with your employer to cut tax withholding from your paycheck. That will immediately increase your take-home pay.