20 Ways to Reduce Your Taxes: A Financially Simple List
Christmas is almost here 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!
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.
- 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.
- 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.
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- 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.
- 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.
- 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.
- 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.
- 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.