How do you save money on income taxes? For most people what they annually pay to the federal and state governments for income taxes is one, if not the largest, cash outflows they make each and every year. Yet people do not pay as close attention to managing their income taxes as they should. Here are some ideas from my upcoming book, The FinancialVerse Guide to Savings - 600 Cash Savings Ideas, which shares cash savings tips that can help you.
In filing your income tax returns, remember that the pandemic has negatively impacted the government staffs that process your returns. In particular, the Internal Revenue Service has announced that the earliest they will take returns for processing will be February 12th and that taxpayers should assume that it will take longer to process refunds this year. So for the current year, you should file early if you are expecting a refund.
As I have stated in all of my books, you should consult a qualified tax professional when adopting a tax strategy or determining how an item should be reported for federal and state income tax purposes. With that in mind let’s look at some ideas that could save you precious cash. This list is not meant to be all encompassing but has been created to provide ideas on where to look for savings.
Maximize your retirement contributions. Contributing as much as you can to your accounts for your latter years can create tax benefits for you by reducing your current taxable income. If you are self-employed, you can also make tax-deductible contributions to a Simplified Employee Pension account or SEP IRA.
Fund a health savings account. Another way to reduce your taxable income is to contribute to a health savings account (HSA). (You need what is known as a high deductible health plan to do this.) HSAs are also a great way to accumulate assets for when you stop working. The money you put in a HSA has triple tax advantages. The contributions go in pretax, you can withdraw it tax free for qualified medical expenses and any money you do not use can be invested and, as with an IRA or 401(k) plan, the gains are tax deferred.
Collect available tax credits. There are a significant number of tax credits available that are valuable because they reduce your tax bill on a dollar-for-dollar basis. For example, credits are available to families with children with low or modest incomes (the Earned Income Credit), families can get a credit for each child under age 17 and for parents who use a daycare or childcare service may also be eligible for the federal Child and Dependent Care Tax Credit. Check with your tax advisor to go over the list of credits, any restrictions on how they can be claimed and which ones are available to you.
Research available deductions. Work with your tax advisor to look for all deductions you are entitled to including mortgage interest, real estate and property taxes and medical expenses to see if you have enough to itemize your deductions. The Tax Cuts and Jobs Act raised the bar on who will itemize, as you now must surpass the 2020 standard deductions of $12,400 for singles or $24,800 for a married couple filing jointly.
Invest in municipal bonds. Buying a municipal bond essentially means lending money to a state or local entity for a set number of interest payments over a predetermined period. Interest earned on municipal bonds is exempt from federal taxes and may be tax exempt at the state and local level as well depending on where you live.
Plan for long-term capital gains. Investing can be an important tool in growing wealth. An additional benefit from investing in stocks, mutual funds, bonds and real estate is the favorable tax treatment for long-term capital gains.
Establish an IRA. Individual Retirement Accounts are a straightforward, easily accessible way to cut your taxes the same way the 401(k) does, but they have strict rules. If neither you nor your spouse participate in a workplace retirement plan, then for 2020 you can contribute $6,000 ($7,000 if you're 50 or older) to an IRA and take that off your taxable income—even if you don't itemize deductions. There are other restrictions and limitations you need to consider before opening such accounts.
Keep track of your costs of supporting charities. Add up all out-of-pocket costs of doing good. Keep track of what you spent while doing charitable work, from what you spent on stamps for a fundraiser, to the cost of ingredients for casseroles you made for the homeless and be sure to track the number of miles you drove for charity. Add such costs with your cash contributions when figuring your charitable contribution deduction.
Your residential energy saving expenditures may be tax friendly. A tax credit is available for homeowners who install alternative energy equipment. It equals a percentage of what a homeowner spends on qualifying property such as solar electric systems, solar hot water heaters, geothermal heat pumps and wind turbines, including labor costs. There is a cap on this tax credit of 26% for expenditures made in 2020.
Caregiving expenses may have tax benefits. After taxes it can easily take $7,500 or more of salary to pay $5,000 worth of childcare expenses. If you use a childcare 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. The maximum you can set aside tax free is $5,000. If your boss offers such a plan, take advantage of it. This isn't just for children. If you have a spouse or relative who is physically or mentally incapable of self-care and lives in your home, they're eligible too. The tax law also expands to allow Achieving a Better Life Experience (ABLE) accounts, which permits families to put aside up to $15,000 a year to cover expenses for a beneficiary with special needs.
Look carefully at the availability of your work tuition reimbursement plans. Companies can offer employees up to $5,250 of educational assistance tax free each year. This amount is not taxable to you and is treated as a tax-free fringe benefit. It could really help you pay to improve your knowledge and skills. In this time where many people are upskilling or reskilling to keep or qualify for new jobs this benefit could really come in handy.
Summary
There are numerous tax credits, deductions and special provisions in our federal and state income tax codes. You may be able to use them to your benefit. The key is awareness of what is available and how to qualify. Using tax preparation apps and tax preparation services should help you get what you are entitled. Good luck as you begin the research.
If you're looking for ideas on where to find cash savings, please buy my new book, The FinancialVerse Guide to Savings – 600 Cash Savings Ideas.
The book is priced at $16.99 for print and only $3.99 for the eBook. Cash Savings provides practical suggestions for where you should look for savings as part of your day-to-day life. For most households, I believe they will find at least $600 in annual savings.