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What do you think of when you hear the word "taxes?" Some people think it's theft! Some people think they are needed for the US to thrive as a nation. And they think people who make more money should pay the most taxes. From what I've found with our clients, most people think of taxes as a necessary nuisance.
Today I wanted to talk about how to become more efficient with your tax planning. I also want to cover a few myths that we generally make mistakes with when it comes to taxes.
I hear a lot of questions from clients around the tune of "How can I reduce my taxes? I got my butt kicked last year."
I'll start at the federal level for taxation. In a future blog, we'll talk about the tax brackets and state taxes.
I'm not a CPA. So for everything here, double check with a CPA.
1. The first option to reduce taxes is to make less.
Most people don't like that option, so let's move on to number two.
2. You can maximize your deductible retirement accounts to pay less in taxes today.
Your 401(k) can now help you reduce your taxable income by $19,000 per year if you choose to defer that much.
MYTH: You can only save what your employer matches into your 401(k). Totally false! Often I hear clients mix up their terminology by saying they area "maxing out" their 401(k). In their eyes the employer matches five percent, so by contributing five percent they think they've maxed it out. Not the case!
If you make $190,000 per year, you can contribute 10 percent of your income to your 401(k), and the employer would only match 5 percent. The math still works at lower numbers. If you make $60,000 per year you can contribute $19,000—or 31.7 percent of your income! Again, your employer (based on their match limits, in this case five percent) will only match $3,000, or five percent.
You can also contribute up to $6,000 towards your IRA (Individual Retirement Account). This does phase out with increases in income. But for most Americans, you can put away up to $24,000 pre-tax. That lowers your taxable income for this year.
Source: CNBC
There are many other unique cases, such as someone over 50 who is able to put away an extra $6,000 into 401(k) plans and an extra $1,000 into IRAs. Or a small business owner who opens a Solo 401(k). They can stock away $56,000 in total pre-tax with all of their accounts! The problem is that your business must generate that revenue. You can't work a normal W2 job making $100,000 per year with a side-gig making $12,000 per year and think that the IRS will allow you to side-step taxes like that!
3. Adjust your healthcare premiums or consider an HSA.
A lot of times when clients feel strapped for cash we recommend that they move to a high-deductible health care plan. It means they pay less for month to month premiums and a higher deductible if they need health care. When it comes to lowering taxes, that doesn't really help, as it sends more money home, which means higher income taxes.
There are two ideas to lower your taxable income as you play around with health care.
- Use high-deductible plan and save more money pre-tax into an HSA (Health Savings Account). An HSA allows you to put away money pre-tax and use it for health expenses tax free! It lowers your taxable income, so you pay less taxes today. $3,500 per year per person can be set aside in an HSA and roll over to the next year!
- Use a low deductible plan and pay more in health care premiums. This doesn't sound fun, but if you pay them up front, your premiums are tax deductible and then will lower your out of pocket expenses when you need to use a health care provider. This strategy could make more sense for some families with higher incomes that want to reduce tax liability and have some regular need for doctor visits, like diabetes management or chronic illnesses.
MYTH: 1099 contractors don't pay taxes. Totally false! Their taxes aren't withheld from them for their employment, so they do have to pay them on their own! In today's gig economy this can bump a family up to the next bracket if they are doing multiple side gigs. And then you end up paying more in taxes, and on your own! So the healthcare premium strategy can be really efficient for 1099 workers.
4. Monitor other taxes.
Some other things to consider when it comes to being efficient with taxes are estate taxes and gifting. When someone passes away their estate, they can pass down up to $5.6 million per person at a federal level before estate taxes kick in. Be sure to work with a CPA, financial advisor, and an Estate Planning Attorney to implement these ideas but if a families' net worth is climbing they can do a few things:
- Set up an Irrevocable Trust. By placing assets into a trust a family can get the net worth out of their estate.
- Give money away. Donations to family members or charities can go towards reducing estate taxes. For example Grandparents could give $15,000 each per year per grandchild towards a 529 college education plan. If they did that for a few years that could certainly reduce an estate below the taxable estate threshold.
MYTH: Getting a refund from the government is them giving you extra money back. Actually all you're doing is paying extra in taxes and allowing them to use it interest free and then give you back the leftovers.
If you feel like you're paying too much in taxes and then every year you get a refund, THEN YOU ARE PAYING TOO MUCH IN TAXES! It turns out that after the 2018 tax law changes, people aren't getting the refunds they planned on, and now they're pissed!
Source: CBS
We've all heard the joke, "There are two things that a certain in life. Death, and taxes." We try to eat healthy, workout, and make smart decisions, like not smoking and wearing our seat belt. So all I'm saying with this post is take some actions to be more effective with taxes too!
About the Creator
Isaiah Goodman
Isaiah is a Certified Financial Education Professional TM and a dynamic speaker who loves to empower others. Isaiah has been married to his wife since 2012. At home they are joined by their four children and dog.
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