How to slim down your tax bill
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Tax-filing season will begin in a few weeks, bringing with it the sounds of wailing and gnashing teeth as millions of Americans attempt to navigate the IRS' endless stream of forms, schedules and instructions. But while filing taxes will probably never be fun, it can be an opportunity to reconsider your finances—and save thousands of dollars in the process.
The secret is to get in the habit of thinking through the tax implications of your important life choices. Based on your lifestyle and financial position, your home expenses, car mileage, schooling, and even the computer paper you buy could lead to major deductions. Here are a few places to start:
1. Look at your retirement
Many employers offer two major types of retirement plans: traditional 401(k)s and Roth 401(k)s. With traditional plans, you contribute to the account before paying taxes, while Roth contributions go in after taxes.
"If you asked millennials which is better, I bet most will say that Roth is the 'good' 401(k)," says financial planner David M. Barral. The reason is that young workers assume that as they approach retirement, they will be in a higher tax bracket, so it seems to make sense to pay taxes now, while their tax rate is lower.
But there are other factors in play, Barral says. To begin with, when you make pre-tax contributions to a traditional 401(k), you reduce your take-home pay, which could push you into a lower tax bracket. And, by delaying your tax payments, you get even more money to invest—which, effectively, means that you're getting an interest-free loan from Uncle Sam.
On the other hand, let's say you have student loans outstanding. As your income goes up, the federal government starts to phase out your tax deduction for student loan interest payments. Saving money for retirement after taxes with a Roth 401(k) means you get to that phase-out point faster, Barral explains.
2. Consider home ownership
With monthly rents in their south Atlanta suburb nearing the cost of a monthly mortgage payment, Tyler Willis, 31, and his wife decided to buy a first home a few months ago. Now, they're able to deduct home loan interest and property taxes from their federal tax return. In 2019, they plan to put the savings into a rainy day savings account. "Some of us millennials start saving early in life," Willis jokes.
Buying a home makes sense for the Willises, but Barral suggests taking a good look at your expenses before you sign on the dotted line. If your annual tax deductions, including mortgage interest, charitable gifts and state and local taxes, don't exceed $12,000 ($24,000 for married couples filing jointly), then you won't be able to itemize deductions. In other words, the tax benefit you would get from home ownership would evaporate.
Nick Preusch, tax manager
3. Keep every side-hustle receipt
If you are self-employed or have a side gig outside your full-time job, take a good look at your expenses. The packing envelopes you buy for your Etsy side gig and the miles you drive for your Fiverr gig assembling furniture could pay off!
Log your mileage each time you drive for your side job and save your receipts for computer paper, office supplies, web hosting, and other work expenses, says Nick Preusch, a tax manager. The IRS says those "ordinary and necessary" expenses that carry on a trade or business are tax-deductible. Also, see if you qualify for deductions for setting up a home office and for buying health and dental insurance as a self-employed person.
4. Think about returning to school
Graduate school could put you in a better position for the job market—and give you a tax break. The government offers two options: a federal lifetime learning tax credit of up to $2,000 for school expenses and a tuition and fees deduction of up to $4,000. Preusch suggests comparing the numbers on both deductions and seeing which one is more favorable.
In addition to reducing your taxes, school credits also lower the income figure that the government uses to calculate the annual repayment on existing student loans. A lower income translates into a lower minimum payment. In other words, by going back to school, you could put yourself in a position to earn more money, while paying less on your student loans!
You also might look into state-run 529 savings plans. Most people only think about 529 accounts for their children's future college expenses, but adults also can use them to invest in their own graduate school. As an added plus, Preusch says, you aren't taxed on the earnings.
5. Investigate fringe benefits
When your company asks you to re-enroll in employee benefit plans, think about the tax impact, Barral says. For example, if your company offers a flexible spending account, you can divert up to $5,000 a year tax-free to pay for medical care, dependent expenses like pre-school, or adoption expenses. Some companies also allow employees to set aside up to $260 a month from their pre-tax earnings to spend on transit or parking.
Finding deductions can be difficult, but Preusch says that many taxpayers are becoming comfortable with using online resources to plan their big purchases. "It's like when WebMD came into vogue 10 years ago, and people were going into their doctor's office having already done some self-diagnosing," he says. "People are getting more comfortable with tax information. I think it's a good thing."
John McKenna is a Chase News contributor. He has worked for the Bond Buyer, Public Accounting Report, and the Atlanta Business Chronicle, among other publications. the Atlanta Business Chronicle, among other publications.