It’s October. If you’re like me, you’re enjoying pumpkin spice anything (Seinfeld was right in saying, “people love cinnamon”), asking your kids to just pick one Halloween costume, and tempering early Christmas list requests. As a CPA, I’m also thinking about ways to lower my clients’ taxable income or at least lessen the blow once it’s time to file their taxes early next year.
Whether you prefer to receive a tax refund or diligently save for your tax bill, I find that most people are looking for strategies to maximize their after-tax wealth. Here are 10 ways you may want to consider to help you save on taxes and set yourself up for a better financial future:
1. Review your withholdings
If you work as an employee and receive a W-2, take a look at your W-4 and current tax withholdings. There are major changes in the tax laws starting in 2018 around credits and deductions, so the tax withholdings based on your current W-4 might not be appropriate. Also, your filing status and family size may have changed since you last completed a W-4.
If you claim too many allowances, you may not have enough income taxes withheld during the year. If you tend to owe additional taxes and would prefer to get a refund, consider having more taxes withheld from your paycheck throughout the year. The IRS has a great tool on their website that can help you perform a quick “paycheck checkup.”
2. Increase 401(k) contributions
If your employer offers a 401(k) plan, you have until December 31 to max out or contribute more to your 401(k) as an employee. Doing so will lower your taxable income now while saving for your future self. If your budget can swing it, log in to your 401(k) account and bump up your contribution through the end of the year. For 2018, you can contribute up to $18,500 or $24,500 if you’re 50 or older.
3. Max out traditional or Roth IRA contributions
Another way you can start saving for retirement is by contributing to a traditional or Roth IRA. This is regardless of whether earned income is from self-employment or traditional employment. You have until April 15, 2019 to establish and make a contribution for the 2018 tax year. For 2018, individuals can contribute up to $5,500 ($6,500 if you’re age 50 or older) or their taxable compensation for the year if that figure is lower.
While contributing to a Roth IRA won’t lower your taxable income this year, you can withdraw your money tax-free when you’re in retirement. However, a Roth IRA contribution might be limited based on your tax filing status and income.
On the other hand, you may be eligible for an income tax deduction by contributing to a traditional IRA. This deduction may be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels. Review the IRS guidelines for more details.
4. Convert a traditional IRA to a Roth IRA
Thanks to the new tax laws, you may find yourself in a lower tax bracket than the previous years. Or perhaps your income is lower this year due to unemployment or starting a business. If that’s the case, now might be a good time to consider a Roth conversion. When you convert an old 401(k) or traditional IRA into a Roth IRA, you’re paying income taxes on this balance at today’s lower tax rates. Any growth in your new Roth IRA investments will be tax-free and won’t impact your taxable income when withdrawn during retirement. Generally, withdrawals are tax-free, although there are some rules that, if not followed, could result in tax penalties.
Be sure to discuss this conversion with your CPA or tax advisor who can advise you of all the options available to you, their features and fees. There are considerations involving taxes, timing and costs that should be taken into account based on your personal financial situation. You should also be aware that the new tax laws no longer allow a recharacterization, or undoing, of the Roth conversion.
5. Take advantage of tax gain or loss harvesting
Investments held for more than one year and sold at a gain will be taxed at the preferential long-term capital gains rate of 0%, 15%, or 20%, depending on taxable income levels. In 2018, the 0% tax rate on capital gains applies to married individuals filing jointly with taxable income up to $77,200 and single individuals with taxable income up to $38,600. Therefore, if you had a year with uncharacteristically low taxable income, now may be the time to sell some investments at a tax-free gain.
You can also offset these gains by selling other poorly performing long-term investments at a loss. If your capital losses exceed your capital gains, the amount of the excess loss that you can claim to lower your ordinary income is the lesser of $3,000, ($1,500 if you are married filing separately) or your total net loss shown on Schedule D. If your net capital loss is more than this limit, you can carry the loss forward to later years.
Both strategies should be reviewed carefully with your investment advisor because tax considerations aren’t the only factor to weigh when selling investments. And while you’re reviewing your investments, take a moment to review your current asset allocation and rebalance them to match your target allocation.
6. Spend your FSA dollars
If you’ve contributed to a tax-deferred flexible spending account through your employer benefits, make sure you spend those dollars by the end of the year. While some plans have a grace period and may let you carry over some money into 2019, others are “use it or lose it.” Unused and forfeited balances will be taxed, so refer to this great listing of eligible healthcare FSA expenses.
7. Accelerate or bunch your charitable contributions
Starting in 2018, the standard deduction is increasing about two-fold to:
- $12,000 for single filers
- $18,000 for heads of household
- $24,000 for married couples filing jointly.
At the same time, State and Local Taxes (SALT) are limited to $10,000 per return and miscellaneous itemized deductions have been eliminated. Therefore, in order to take advantage of itemizing deductions, taxpayers may consider making several years’ worth of deductible charitable contributions all in one year.
8. Contribute to a college savings fund
If you’ve maxed out your retirement savings for the year and want to save for your child’s college education, there’s still time to contribute to a 529 plan. You won’t get a benefit on your federal tax return, but there are tax benefits in over 30 states. Individuals can contribute up to $15,000 ($30,000 for married couples) per student each year, or up to $75,000 ($150,000 for married couples) prorated over a five-year period to someone’s existing account, without incurring a federal gift tax.
9. Sign up for a class from an accredited school
The lifetime learning credit can cut your tax bill by up to $2,000 a year (20% of tuition up to $10,000), depending on your income. This credit is available for all years of postsecondary education and for courses to acquire or improve job skills. While continuing education by an accredited school to maintain a professional license is eligible, if you’re self-employed, you might be better off claiming your education expense as a business deduction.
Unfortunately, couples filing as married filing separate are not eligible to take the credit. Same for couples filing jointly with modified adjusted gross income of $132,000 or more or individuals filing as single, head of household, or qualifying widow(er) with modified adjusted gross income of $66,000 or more.
10. Reflect on your finances and get ready for next year
This is a great time to review your personal finances. Are you on track to meet your financial goals? Also take a few moments to review your budget (including holiday spending), insurance coverage, your estate plan, and account beneficiaries.
Before the business of the holiday season, take some time for a tax tune-up with your CPA. Because what’s scarier? Running out of Halloween candy or a surprisingly large tax bill?
Cathy Derus is the founder of Brightwater Accounting. As a CPA and financial planner, she helps individuals and business owners eliminate stress and worry over taxes, business finances, and more. Anyone can throw numbers into tax software. She’s here to help her clients make sense of those numbers and create a better financial strategy for their businesses and lives. Her expertise has been featured in Entrepreneur, CNBC, US News & World Report, The Washington Post, Real Simple and Cosmopolitan.
Haven Life Insurance Agency does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.