Every year around this time, I always have people frantically ask “What can I do to save on my taxes?” Probably the most common answer is “It depends.” There isn’t a strategy or method that works for every taxpayer in every situation. However, there are a few principles to follow and then some specific ideas each year that you might be able to use to your advantage.
1. Pay the least amount of tax possible. This seems obvious, but it isn’t always as straightforward as it sounds. For example, if the tax rates are scheduled to increase next year, then maybe I want to trigger income for this year so that I don’t have to pay the higher rate on it next year. Overall, you will be paying the least amount of tax, but you have to look at it from a multi-year perspective.
2. Timing. Most people are cash basis taxpayers. That means that they pay taxes on income based on when they receive the money and can claim deductions based on when they actually pay for the expense. For example, I went ahead and paid my wife’s tuition for the spring in December, so that I can claim a bigger tuition credit this year instead of waiting until next year. Likewise, I’m putting of some extra business expenses until next year so that I can reduce the amount of self-employment tax I’ll have to pay next year.
Now for the specific ideas. You will see that most of them use the principles above.
1. Find out where you stand. Some people’s tax situation doesn’t change a whole lot from year to year. However, if you lost a job, got a new job, started a business, started a family, bought a house, or had a major change in your life, I guarantee that this year won’t be just like last year. Take a look at your income and expenses for the year to see how it compares and to get a starting point for planning.
2. Charitable Contributions. If you have enough to itemize your deductions, go ahead and clean out your garage. Make a trip down to your local goodwill with the extra stuff, just be sure to get a receipt. Since goodwill doesn’t always give a detailed receipt, it is helpful to jot down what all you donated. An old tv, microwave, and a box of clothes is worth a bigger deduction that just knowing you dropped off a box of stuff from the garage during December.
3. Capital Gains. I wrote a post earlier about the unique rules regarding capital gains this year. I suggest you read it here. The extremely short version is that if you are in a low enough tax bracket, capital gains are tax free this year. Please read the post to find out if it would make sense for you.
4. Timing. Like I said above, once you know where you stand, you can see what you need to do for tax planning. If you started a business and are showing a big profit, maybe now would be a good time to go buy some equipment or prepay for some advertising for next year. If you have a baby on the way… you’ve still got two weeks to push. (ok. just kidding about that one!)
5. If you have a business, make sure you are using the correct entity for tax purposes. Maybe it’s time to incorporate or make an S-corp election for your LLC. This can get more complicated than I can address as a tax tip, but the results can be huge. How does paying half as much in self-employment next year sound? I’ve seen it happen for many small businesses. Contact your CPA and ask if this would make sense for your business.
6. Save for retirement. Make sure you are taking advantage of your company’s retirement plans. If your company doesn’t have a plan, set aside some money in an IRA or Roth IRA. What’s the difference? IRA’s give you deductions now and you pay taxes on the money when you take it out. Roth IRA’s don’t have a deduction now, but the money is tax-free when you take it out. So if you think your tax bracket will be higher after retirement, choose a Roth. If you think your tax bracket will be lower later, choose a standard IRA. Either way, the money grows tax free in the meantime.
7. Energy Credits. There are several tax credits available for energy efficiency improvements to your personal residence. I recommend looking at the information on the Energy Star website to see what improvements qualify and the amount of the credits involved. The credits aren’t huge, but if you’re going to be making improvements anyway, it’s definitely something to think about.
There are many ways to save on taxes but they always depend on your situation. I hope the above ideas will be helpful and get you started on your tax savings plan. Let me know what you are doing to save in the comments below.