Top 7 Ways to Reduce Your Income Taxes
By: Kristine McKinley, CFP, CPA
Are you paying too much in income taxes? Are you getting all the credits and
deductions you are entitled to? Here are 7 tips to help you minimize taxes and
keep more in your pocket:
1. Participate in company retirement plans. Every dollar you contribute will
reduce your taxable income and thus your income taxes. Similarly, enroll in your
company’s flexible spending account. You can set aside money for medical
expenses and day care expenses. This money is “use it or lose it” so make sure
you estimate well!
2. Make sure you pay in enough taxes to avoid penalties. Uncle Sam charges
interest and penalties if you don’t pay in at least 90% of your current year
taxes or 100% of last year’s tax liability.
3. Buy a house. The mortgage interest and real estate taxes are deductible, and
may allow you to itemize other deductions such as property taxes and charitable
donations.
4. Keep your house for at least two years. One of the best tax breaks available
today is the home sale exclusion, which allows you to exclude up to $250,000
($500,000 for joint filers) of profit on the sale of your home from your income.
However, you must have owned and lived in your home for at least two years to
qualify for the exclusion.
5. Time your investment sales. If your income is higher than expected, sell some
of your losers to reduce taxable income. If you will be selling a mutual fund,
sell before the year-end distributions to avoid taxes on the upcoming dividend
or capital gain. Also, you should allocate tax efficient investments to your
taxable accounts and non-efficient investments to your retirement accounts, to
reduce the tax you pay on interest, dividends and capital gains.
6. If you’re retired, plan your retirement plan distributions carefully. If a
retirement plan distribution will push you into a higher tax bracket, consider
taking money out of taxable investments to keep you in the lower tax bracket.
Also, pay attention to the 59 ˝ age limit. Withdrawals taken before this age can
result in penalties in addition to income taxes.
7. Bunch your expenses. Certain expenses must exceed a minimum before you can
deduct them (medical expenses must exceed 7.5% of your adjusted gross income and
miscellaneous expenses such as tax preparation fees must exceed 2% of your AGI).
In order to deduct these expenses, you may need to bunch these types of expenses
into a single year to get above the minimum. To achieve this, you might prepay
medical and miscellaneous expenses on December 31 to get above the minimum
amount.
The most important thing is to be aware of the tax deductions and credits that
apply to you and to plan for taxable events. And don’t be afraid to ask for
help. The benefits from consulting an experienced tax professional far outweigh
the cost to hire that professional.
Article by:
Kristine A. McKinley, CPA, Certified Financial Planner®, and founder of Beacon
Financial Advisors, teaches people how to invest and plan for retirement,
college, and other financial goals. Kristine offers financial and tax planning
on an hourly, fee-only basis. Learn how improving your credit score can save you
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