Minimize Your Taxes
As the old saying goes, “nothing is certain but death and taxes.” Even though it sometimes feels like any tax is too much tax, there are some things you can do to work through your income tax return and reduce your taxes!
The current Federal Income tax brackets range from 10% to 37%. But if you are smart about claiming deductions and credits, you can develop a plan to pay less in taxes. However, be aware that tax credits and deductions change regularly. The Tax Cuts and Jobs Act of 2017 eliminated some popular deductions and limited others, so some options for deductions may have changed.
Below are some suggestions to minimize possible tax liability:
Contribute to a Retirement Account
Retirement account contributions are a top tax-reduction tool.
Contributions to traditional 401(k) and IRA accounts can be deducted from your taxable income and reduce the amount of federal tax you owe. As a bonus, these funds also grow tax-deferred until retirement! If you start early, saving money in these accounts can help secure your retirement.
While contributions to workplace 401(k) accounts must be made by the end of the calendar year, tax-deductible contributions can be made to traditional IRAs up until the July 15 filing deadline for taxes filed in 2021.
Contribute to a Health Savings Account
If you have an eligible high-deductible medical plan, contribute to a health savings account (HSA). Contributions to HSAs offer an immediate tax deduction, growing tax-deferred. Funds can be withdrawn tax-free for qualified medical expenses. Any balance left at the end of the year can roll over indefinitely, similar to the assets in a retirement account.
Use Your Side Hustle to Claim Business Deductions
Self-employed individuals (full-time or part-time) are eligible for numerous tax deductions. That means your freelance projects or side gig as a ride-share driver could land you considerable tax savings.
A few of the business deductions available include: business-related vehicle mileage, shipping, advertising, website fees, percentage of home internet charges used for business, professional publications, dues, memberships, business-related travel, office supplies, and other expenses incurred to run your business. Additionally, if you pay for your own health, dental, or long-term care insurance, those premiums may be deductible, too. Just be sure to maintain records and consult your accountant for proper deductions.
Claim a Home Office Deduction
If you work for yourself or have a side business, do not be afraid to take the home office deduction. This allows you to deduct a percent of your home expenses using Schedule C.
However, to qualify for the deduction, the space must be used regularly and exclusively for business purposes. For instance, if an extra bedroom is used only as a home office and it constitutes one-fifth of your apartment's living space, you can deduct one-fifth of rent and utility fees.
Write Off Business Travel Expenses
While a regular business trip is an obvious deduction, there are also ways to reduce tax burdens with other travel. By combining a vacation with a business trip, you could reduce vacation costs by deducting the percent of the expenses spent for business purposes. This could potentially include airfare and part of your hotel bill, proportionate to the time spent on business activities. Make sure to speak with your tax professional about how to make this calculation correctly.
Deduct Self-Employment Taxes
The government assesses a 15.3% Federal Insurance Contributions Act tax on all earnings to pay for the Social Security and Medicare programs.
While employers split the cost with their workers, self-employed individuals are responsible for paying the entire amount themselves. To compensate for the extra expense, the government will let you deduct 50% of the amount paid from your income taxes. You don't even need to itemize to claim this tax deduction, so make sure you take advantage of this deduction!
Credit for Higher Education
The government offers valuable tax credits to offset the cost of higher education. The American Opportunity Tax Credit can be claimed for the first four years of college and provides a maximum credit of $2,500 per student per year.
Since it's a credit, that amount is deducted from whatever tax you owe. However, if it exceeds the amount of tax you owe, up to $1,000 may be refundable to you!
Additionally, the Lifetime Learning Credit is great for adults boosting their education and training. This credit is worth up to $2,000 per year and helps pay for college and educational expenses that improve your job skills.
Earned Income Tax Credit
Even if you are not required to pay federal income taxes, you could be eligible for a refund from the government. The EITC is a refundable tax credit of up to $6,557 for tax year 2019.
This credit is calculated with a formula that takes into consideration income and family size. The income limits for the credit range from $15,570 for single taxpayers with no children to $55,952 for married couples filing jointly who have three or more children. A tax professional will be able to help you determine your eligibility for this credit.
Itemize State Sales Tax
Taxpayers who itemize their deductions can include either their state income tax or state sales tax on their Schedule A form. The state sales tax break is a great option if you live in a state without income taxes.
While taxpayers can use a table provided by the IRS to easily claim their sales tax deduction, remember to add on the sales tax from any major purchase such as a car or boat.
The federal tax deduction for state and local taxes is capped at $10,000 from all sources.
Adjust Your Basis for Capital Gains Tax
When calculating the cost basis after selling a financial asset, investors should make sure to add in all of the reinvested dividends. That increases the cost basis and reduces capital gain when selling the investment.
If you sell your house, you may end up paying capital gains tax as well, particularly if your property's value has risen significantly.
Single taxpayers can exempt up to $250,000 of their home's appreciation from capital gains tax and married couples get a $500,000 exemption. The IRS only allows the exemption to be claimed once every two years. However, you can reduce how much you owe if you have made home renovations or improvements. Any investment you make can be deducted from the capital gains.
Minimize Capital Gains Tax by Donating Stock
Another way to minimize capital gains is by using stocks to make charitable gifts. You can move stocks that had big gains directly into a donor-advised fund. Money moved into a donor-advised fund is not only exempt from capital gains tax, but can also be deducted by those who itemize.
Claim Deductions for Military Members
Are you in the military reserves, such as the National Guard, or an active-duty service member?
If you travel more than 100 miles from home and need to be away overnight, you can deduct unreimbursed travel expenses such as transportation, meals, and lodging. If you're an active-duty service member, you can deduct any costs associated with moving for a permanent change of station. Remember to keep documentation for these expenses.
Qualified Dividends vs Ordinary Dividends
A dividend is a share of a company’s profits that is distributed to shareholders. For tax purposes, there are two kinds of dividends: qualified and ordinary. Qualified dividends come with a lower tax rate.
Three things usually determine whether a dividend is qualified:
1. It is paid by a U.S. corporation or qualifying foreign entity.
For many investors — be they in stocks, mutual funds or ETFs — this one’s easy to satisfy.
2. It is actually a dividend in the eyes of the IRS.
Some things don’t count as dividends, despite what they might be called, including:
· Premiums an insurance company kicks back.
· Annual distributions credit unions make to members.
· “Dividends” from co-ops or tax-exempt organizations.
3. You held the underlying security for long enough.
The definition of “enough” is tricky, but typically, if you owned the security for more than 60 days during the 121-day period that began 60 days before the ex-dividend date — that is, the day by when you must own the stock to receive the dividend — the dividend is usually qualified.
For example, if your company shares paid a dividend on September 1 and the ex-dividend date was July 20, you would need to have owned your shares for at least 61 days between May 21 and September 19. When you calculate the days owned, remember to include the day you sold the shares, but not the day you bought them.
If you do not hold the shares long enough, the IRS might deem them non qualified, and you will pay tax at the higher, non qualified rate. You should be provided a 1099-DIV, showing the breakdown between qualified and ordinary dividends, but remember that there are many exceptions and unusual scenarios with special rules. (See IRS Publication 550 for the details: https://www.irs.gov/pub/irs-pdf/p550.pdf) A qualified tax professional will be able to walk you through this process.
As tax season is upon us, it’s time to consider all of these options for tax reduction. It can be confusing and even overwhelming knowing where to start. As your Financial Advisor Online, I’m here to help you navigate through situations just like this. Contact me today if you have any questions on how to minimize your tax bill for the 2020 filing!
The opinions/views within do not necessarily reflect those of Voya Financial Advisors. In addition, they are not intended to provide specific advice or recommendations for any individual, attorney, accountant. Investment adviser representative and registered representative of, and securities and investment advisory services offered through Voya Financial Advisors, Inc. (member SIPC).Neither Voya Financial Advisors nor its representatives offer tax or legal advice. Please consult with your tax and legal advisors regarding your individual situation.