7 Ways to Reduce Your Taxes
The tax season is in the rear-view mirror, so now is a great time to start planning for next year’s returns. Before you put your returns away for good, spend some time reviewing your data. Review your income, deductions, and expenses to see if you can find an opportunity to make changes.
The state and local tax (SALT) limited the deduction to $10,000, a problem for most filers. This limitation especially hurt residents in California, New York and New Jersey. Texas residents also felt the pinch due to the state’s high property taxes.
Let’s look at a few ideas and strategies you can incorporate today to potentially help you lower your taxes.
- Increase your 401(k) contribution to maximize your deduction. The amount you can contribute this year is $19,000 if you’re under 50. If you’re older than 50, you can add another $6,000. The increased contributions will lower your taxable income and the investments will grow tax deferred.
- Contribute to a traditional IRA. You’re allowed to deduct 100% of your contribution if your income is below $64,000 if you’re single or $103,000 if you’re married. Your investments will grow tax deferred and you don’t have to withdraw your money until age 70 ½.
- If you’re self-employed, consider a SEP-IRA. The maximum amount you can contribute to your plan is $56,000. The formula for your contribution is 25% of your compensation or $56,000, whichever is less. When you retire, or you’re no longer self-employed, you can rollover your balance to an IRA.
- Tax-free municipal bonds are a great way to generate income and lower your taxes. Residents in California and New York must buy bonds from their home state to receive 100% tax free income. Residents in Texas or Florida can buy bonds from any state because they don’t have a state income tax. To compare a tax-free bond to a taxable one, multiply the coupon rate times 1.4. For example, if a tax-free bond pays 3%, then the taxable equivalent is 4.5%. Of course, the higher your tax bracket, the better the after-tax rate. The actual formula is (coupon divided by 1 – your tax rate).
- A health savings account (HSA) can give your returns a healthy boost. A family can contribute $7,000 and a single person can add $3,500. If you’re older than 55, you can add an extra $1,000 to your contribution. The tax deduction for a family is $2,700. A single filer can deduct $1,350.
- Charitable contributions are a great way to help others and reduce your taxes. The standard deduction increased to $24,400 for married couples ($12,200 for single households), so charitable contributions may have dropped off because people didn’t have enough itemized deductions. However, if you’re in a situation to give more than the standard deduction, then charitable contributions make sense. Donor advised funds (DAF) and other strategies can help concentrate, or bunch, your donations to make sure your contribution is more than the standard deduction. In addition, you can give away $15,000 per person, per year free of taxation for all parties.
- Buying growth stocks can also help lower your taxes. How so? Most growth companies don’t pay dividends. If you buy a growth company, your gain (or loss) will occur when you decide to sell. Companies like Amazon, Facebook, and Alphabet are growth companies that don’t pay dividends so you can benefit from years of growth without paying any income taxes. If you own a combination of dividend payers and non-dividend payers, then buy the dividend payers in your IRA so you don’t have to pay taxes on the current cash flow.
Taxes aren’t all that bad because they provide services that are beneficial to a free-market economy like quality roads, police protection, and safety net programs. If you’ve ever visited a third world country, you know what I’m talking about. However, you don’t have to give more money to the government than what’s legally required.
So, dust of your 2018 tax returns one last time so you can find a few opportunities to lower your taxes.
Then Jesus said to them, “Give back to Caesar what is Caesar’s and to God what is God’s.” ~ Mark 12:17
April 25, 2019
Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose.
Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation.