“Taxes are the lifeblood of government and no taxpayer should be permitted to escape the payment of his just share of the burden of contributing thereto.”
– Arthur T. Vanderbilt
“The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether to avoid them, by means which the law permits, cannot be doubted.”
– George Sutherland
I agree with both of the above quotes. If you live in this society, you should pay taxes. After all, you benefit from having a military, roads, schools, fire, police, etc.[ad#Google Adsense 336×280-IA]On the other hand, you shouldn’t pay a penny more than you’re legally obligated to.
It might be too late for you to do anything about the tax bite you’ve already incurred for 2013, but there are things you can do to ensure that Uncle Sam doesn’t take more than his legal share this year.
Here are five ideas…
Make your investments tax-efficient.
This is easier than it seems and doesn’t require you to load up on muni bonds.
Think about your various investments. Will you be taking capital gains this year or generating income? If you expect to capture big capital gains, especially if they’re short term, those are probably better off in your tax-deferred accounts like an IRA or 401(k).
Short-term capital gains are taxed at your ordinary income level, which will likely be higher than the 15% rate for investment income from dividends.
Long-term capital gains are taxed at the 15% rate for most investors, similar to the tax rate on dividends.
Most long-term investors who don’t plan on selling many stocks during the year will have more dividend or interest income than capital gains. In that case, they’re better off having those income-producing investments in tax-deferred accounts.
Let’s say you have $3,000 in investment income and $1,000 in capital gains. If the $1,000 in capital gains is in your taxable account, you’ll pay roughly $150 in taxes, while the $3,000 in income is tax-deferred until you pull the money out.
That’s especially beneficial to anyone who is reinvesting dividends. That way, the money can grow tax-deferred until you need it and compounding will work even better than if you’re forced to pay 15% per year on every dividend.
If your accounts aren’t structured optimally, it’s very easy to change it up. You don’t have to sell anything. Just call your broker and tell him you want to transfer the assets from one account to the other.
Just make sure you’re not adding more money or investments than you’re legally allowed into an IRA.
The most you’re able to contribute to an IRA in 2014 is $5,500 or if you’re over 50 years old, $6,500.
The maximum contribution for a 401(k) is $17,500.
Which brings me to my next suggestion…
Don’t leave free money in the street. If you’re not putting money into an IRA or a 401(k), it’s like allowing the IRS to have a hand in your pocket every time you get paid.
Yes, times are tough and sometimes it’s hard to squirrel money away when the mortgage has to be paid, the kids need braces, and the car is sputtering and wheezing.
But when you don’t, you’re losing money to the government that you don’t have to pay.
When you have a 401(k), not only does your money grow tax-deferred, but the 401(k) actually lowers how much you’ll pay in taxes.
Here’s an example. Let’s say a family’s adjusted gross income, after all deductions, is $75,000 per year and the family does not contribute to an available 401(k). The family will pay $18,750 in taxes.
If the family contributes 6% or $4,500 to a 401(k), not only does that $4,500 grow tax-deferred, but the taxable income will be $70,500 instead of $75,000, lowering the tax bill to $17,625.
So by saving 6% in a 401(k), the family will actually keep an extra $1,125 in after-tax income.
If you were in a parking lot and found a $100 bill on the ground, you wouldn’t just keep walking, would you? That’s what you’re doing if you don’t contribute to a 401(k) where your employer matches contributions, even if it’s $0.50 on the dollar. You’re giving up free money and that’s just not smart.
Take advantage of flexible spending accounts. If your employer offers flexible spending accounts (FSAs) for dependent care or healthcare, you must take advantage of it. You’re spending money on these expenses anyway. All the FSA does is take the money that you’re going to spend and put it in an account pre-tax, lowering your taxable income.
If you earn $75,000 and expect to spend $5,000 per year on healthcare, you can have $5,000 deducted from your paycheck, prorated throughout the year. However, instead of reporting $75,000 in income to the IRS, you report only $70,000, because the $5,000 was already taken out of your income.
That lowers your tax bill by $1,250 simply by putting money you were going to spend anyway in a separate account.
Many companies offer health savings accounts (HSA). With an HSA, you don’t have to spend the money each year. So in our example, if you only spent $3,000 this year, your HSA would start with $2,000 next year and you can continue to save $5,000 next year, building up the account to pay for significant medical expenses down the road.
Again, you’re saving money that you expect to spend anyway. You’re just getting a big tax break to do so.
Like a 401(k) and IRA, if you’re not taking advantage of this opportunity if it’s available, you might as well just pull up to the IRS building and empty your wallet.
Donate stock instead of cash. You can donate stock to your favorite charity instead of cash. The benefit is you won’t pay capital gains taxes.
For example, let’s say you were going to donate $1,000 to an organization this year. You also have a $1,000 capital gain in a stock that you plan on selling. Instead of selling the stock, taking the capital gain and having to pay tax on it, donate the stock to the charity instead.
You still get all of the deductions of making a charitable donation, while at the same time avoiding the tax on the capital gain.
Keep your receipts. If you have a business, even a small part-time one, or are looking for a job, keep your receipts organized, as you’ll be able to deduct many of the expenses related to your business or job search.
Additionally, if you have a business and a home office, you can deduct a portion of your mortgage/rent, utilities, insurance and maintenance costs. Just don’t go overboard. The IRS looks for people abusing this allowance. But those items can add up to hundreds or even thousands in tax savings during the year.
Employing these strategies and talking to a tax professional who can help you optimize them should enable you to fork over less of your hard-earned money to the taxman in 2014.
Source: Investment U