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All Contents © 2019The Kiplinger Washington Editors
By the editors of Kiplinger's Personal Finance
| August 10, 2018
We’re living in a new tax world now, thanks to the overhaul passed by Congress last year. A number of breaks bit the dust, but some new ones were introduced as well. Your 2018 return will be the first to file under the new rules, but the time to look for tax savings is now.
The following ideas could really pay off in the months—and years—ahead.
One of the best ways to cut your taxes is to set money aside in a tax-deferred retirement account. Not only are you doing the wise thing by saving for a winning retirement – you could trim your income enough to fall into a lower tax bracket.
So if your employer offers a tax-deferred program like a 401(k), make sure that you are:
If you have your own business, you have several choices of tax-favored retirement accounts, including Simplified Employee Pensions (SEPs) and individual 401(k)s. Contributions cut your tax bill now while earnings grow tax-deferred for your retirement.
Since the contribution limits for these programs are high ($55,000 per year if you’re under 50, $61,000 if you’re 50 or over), they can be a substantial shelter for big earnings, if you’ve got them.
Individual Retirement Accounts are a straightforward, easily accessible way to cut your taxes the same way the 401(k) does. But they do have strict rules.
If neither you nor your spouse participate in a workplace retirement plan, then you can contribute $5,500 ($6,500 if you’re 50 or older) to an IRA and wham, take that off your taxable income – even if you don’t itemize deductions.
If you or your spouse do have a plan at work, your deduction might be limited. It depends on your income. This IRS document has more details.
See if your workplace offers an insurance plan that you could combine with a Health Savings Account, or consider opening one yourself if you buy your own coverage. A health savings account lets you put money pre-tax for a wide range of medical bills, including deductibles, co-pays and other medical expenses that aren’t covered by insurance, such as vision and dental care.
An HSA offers a triple tax break: The money you put in escapes all tax—no federal income tax, no state or local taxes, and no FICA taxes), the balance grows tax-deferred (and can be invested in mutual funds), and withdrawals used to pay medical expenses are tax-free.
If you really want to swing for the fences with the tax-savings potential of an HSA, go ahead and fund it with pre-tax money, but pay for your out of pocket health costs with cash in your pocket rather than drawing down HSA funds. It takes real financial discipline (and good health) to pull this off, but it will let your HSA money continue to grow tax-deferred.
The Flexible Savings Account is a bit like the HSA’s little brother. Though it’s only available through employer-sponsored healthcare plans, an FSA also lets you set aside money pre-tax, up to $2,550 a year, for qualified health expenses like deductibles. That’s $2,550 that you won’t pay any taxes on: no federal income tax, no state tax, no FICA. Nothing.
But unlike in an HSA, those funds don’t directly belong to you, and if you don’t spend them by the end of the year, they could revert to your employer. Still, most companies are offering grace periods into the following year for you to spend down the money. You may also be able to roll over up to $550 into the next year’s spending window.
Generally, you can’t use an FSA if you’re enrolled in an HSA (and vice-versa), but there are exceptions.
If you plan to make a significant gift to charity, consider giving appreciated stocks or mutual fund shares that you've owned for more than one year instead of cash.
Doing so supercharges the saving power of your generosity. Your charitable contribution deduction is the fair market value of the securities on the date of the gift, not the amount you paid for the asset, and you never have to pay tax on the profit. However, don’t donate stocks or fund shares that lost money. You'd be better off selling the asset, claiming the loss on your taxes, and donating cash to the charity.
Remember, though, that for this to give you a tax advantage, you need to itemize your deductions. There are options if you want to maximize giving and tax benefits – (read more here.
Tote up out-of-pocket costs of doing good. Keep track of what you spend while doing charitable work, from what you spend on stamps for a fundraiser, to the cost of ingredients for casseroles you make for the homeless, to the number of miles you drive your car for charity (at 14 cents a mile). Add such costs with your cash contributions when figuring your charitable contribution deduction.
Again, you’ll need to itemize your taxes to claim these.
Tax reform created a powerful incentive for people to hang out their own shingle and participate in the gig economy. Under the new tax law, sole proprietors who use Schedule C, as well as pass-through entities—such as S corporations, partnerships and LLCs—which pass their income to their owners for tax purposes, get to deduct 20% of their qualifying income before figuring their tax bill.
For a sole proprietor in the 24% bracket, for example, excluding 20% of income from taxation has the same effect of lowering the tax rate to 19.2%.
There are limitations, though: For many pass-through businesses, for example, the 20% deduction phases out for taxpayers with incomes in excess of $157,500 on an individual return and $315,000 on a joint return.
If you use part of your home regularly and exclusively for your business, you can qualify to deduct as home-office expenses some costs that are otherwise considered personal expenses, including part of your utility bills, insurance premiums and home maintenance bills.
Some home-business operators steer away from these breaks for fear of an audit. But the IRS now makes it easy to claim this tax break. Instead of calculating individual expenses, you can claim a standard deduction of $5 for every square foot of office space, up to 300 square feet. Of note if you were an employee who had a dedicated home office that you used as your principal place of business: Your ability to write off those expenses is gone, with the new tax law’s elimination of miscellaneous itemized deductions.
A tax credit is available for homeowners who install alternative energy equipment. It equals 30 percent of what a homeowner spends on qualifying property such as solar electric systems, solar hot water heaters, geothermal heat pumps, and wind turbines, including labor costs. There is no cap on this tax credit, which is available through 2019. The percentage starts dropping then: 26% in 2020, 22% in 2021, and 10% for 2022 and thereafter.
After taxes, it can easily take $7,500 or more of salary to pay $5,000 worth of child care expenses. But, if you use a child-care reimbursement account at work to pay those bills, you get to use pre-tax dollars. That can save you one-third or more of the cost, since you avoid both income and Social Security taxes. The maximum you can set aside tax-free is $5,000. If your boss offers such a plan, take advantage of it. This isn’t just for children; if you have spouse or a relative who is physically or mentally incapable of self-care and lives in your home, they’re eligible, too.
The new tax law expands also expands ABLE accounts, which allow families to put aside up to $14,000 a year to cover expenses for a beneficiary with special needs. The money can be used tax-free for most expenses, and account assets of up to $100,000 don’t count toward the $2,000 limit for Supplemental Social Security Income benefits. Under the new law, ABLE beneficiaries will be allowed to contribute their own earnings to the account once the $14,000 contribution limit for gifts by others has been reached. The law also allows parents and others who established a 529 plan for a disabled beneficiary to roll the money into an ABLE account for that individual. However, the rollover would count toward the $14,000 annual contribution limit.
If, like most investors, your mutual fund dividends are automatically reinvested in extra shares, remember that each reinvestment increases your tax basis in the fund. That, in turn, reduces the taxable capital gain (or increases the tax-saving loss) when you redeem shares in a taxable account. Forgetting to include reinvested dividends in your basis results in double taxation of the dividends—once in the year they are paid and reinvested and later when they're included in the proceeds of the sale.
Don't make that costly mistake. If you're not sure what your basis is, ask the fund for help. Funds often report to investors the tax basis of shares redeemed during the year. In fact, for the sale of shares purchased in 2012 and later years, funds must report the basis to investors and to the IRS.
It’s easy to figure whether you'll come out ahead with taxable or tax-free bonds. Simply divide the tax-free yield by 1 minus your federal tax bracket to find the “taxable-equivalent yield.” If you’re in the 33% bracket, your divisor would be 0.67 (1 - 0.33). So, a tax-free bond paying 5% would be worth as much to you as a taxable bond paying 7.46% (5/0.67).
Don’t overlook state-tax savings as well. If you live in a high-tax state like California or New York, there are even tax-favored bond mutual funds that pay out interest that’s free from federal and state income tax.
Ask your boss to pay for you to improve yourself. Companies can offer employees up to $5,250 of educational assistance tax-free each year. That means the boss pays the bills but the amount doesn't show up as part of your salary on your W-2. The courses don't have to be job-related, and even graduate-level courses qualify.
If your employer isn’t so generous (or you don’t have one) and you're paying your own tuition for a graduate course or other training, you may qualify for a Lifetime Learning Credit that's worth 20% of up to $10,000 of qualifying expenses. That could knock off as much as $2,000 from your tax bill. The right to claim this tax saver phases out if your income exceeds $50,000 on a single return or $100,000 on a joint return.