The tax season, more than any other time of a year, calls to mind that tax takes a sizable proportion of our income. While we’ve crunched numbers for this year’s tax return, it is never too early to think about how to reduce income tax for the coming years.
1. Maximize 401K contributions
In 2020, the maximum allowed for retirement contribution is $19,500 per person. The higher your income, the more tax you need to pay. By contributing to the tax-deferred retirement account such as 401(k) and 403(b), you may be able to enter a lower tax bracket.
The money you put in this tax-deferred retirement account is subject to tax when you withdraw it after your retirement. However, the tax rate will be most likely lower after your retirement as compared to that while you are employed since your income is usually lower after you retire.
2. Contribute to the Flexible Saving Account (FSA) for dependent care and healthcare
The flexible saving account is a pre-tax benefit account that can be used to pay for eligible dependent care costs such as preschool and summer camp, and healthcare cost such as medical, dental and vision care expenses. The maximum contribution for dependent care FSA is $5,000 per year and $2,750 for healthcare FSA.
3. Use Health Saving Account (HSA)
Health saving account (HSA) could be another way to save money on tax if you and your family are in a good health condition and you don’t foresee any big health cost. You have to enroll in a high-deductible health plan (HDHP) and fund contribution in HAS account can be used to pay your health cost.
The contribution limit is $3,550 for single and $7,100 for a family in 2020 and those contributions are not subject to federal income tax at the time of deposit and can roll over and accumulate year to year if they are not spent. If you are in 25% tax bracket, HSA can save you $888 in tax for single and $1,775 for a couple. Please be aware if you choose HAS, you cannot contribute to healthcare FSA.
4. Deduct moving expenses
If you have moving expenses due to the relocation of a new job or internal transfer, you can deduct your moving expense on the federal tax return if you meet the distance requirement from your old address to the new location.
Short-term capital gains are taxed at a much higher tax rate than long-term capital gains. Avoid short-term capital gains. Take Warren Buffet’s strategy to buy and hold stocks. If you have to sell, sell losers and you can carry over that loss to cancel out future capital gains and lower your taxable income.
6. Deduct depreciation on the part of your property used for rental purposes.
Investing in real estate has great tax benefits. First and foremost is the depreciation from real estate shelters income from tax. For example, a $200,000 building depreciated over 27.5 years provides tax shelter of $7,272 per year. If you are in 25% federal tax bracket, that is $1,818 tax you saved from the depreciation of real estate. Rental income is not subject to social security and Medicare taxes (FICA). The tax benefits from real estate investing are incredible.
However, the hassles to deal with tenants may deter some people from entering into real estate investing. Not everyone is willing to deal with terrible tenants and midnight maintenance requests. Do your homework and figure out what’s best for you.
7. Deduct home business costs
If you’re self-employed working primarily from home, you may deduct your business-related costs such as rent, maintenance, utilities, and transportation. These costs can offset the income obtained from the business. Be sure to keep a good record of your business expenses.
8. Deduct educational expenses
You may be able to deduct up to $2,500 of the interest you paid on a qualified student loan. The deduction is claimed as an adjustment to income. You may also deduct qualified education expenses for higher education paid during the year for yourself, your spouse or your dependent. In addition, you may deduct work-related education expenses from your income.
9. Claim homeowner credits
If you make your home more energy efficient through new insulation, windows, doors, and roofs in the prior year, you may qualify for a tax credit on your federal income tax return. IRS website provides details on which credit and how much you can take.
Lower-income individuals can claim mortgage interest credit. To qualify, you must contact the appropriate government agency for a Mortgage Credit Certificate before getting a mortgage or purchasing a home.
10. Claim education credits
If you paid qualified tuition and required enrollment fees at an eligible educational institution, you can claim the tax credit for up to $2,000 as the lifetime learning credit, if your income meets certain requirements.
11. Claim dependent credits
The maximum dependent care expense you can use to calculate this tax credit is $3,000 per child. You may qualify tax credits between $600 and $1,050 per child depends on your gross income. Note if you already contributed pre-tax amounts to dependent care FSA, you need to deduct those amounts from your taxable dependent care expense.
For each qualifying child, you can have up to $1,000 child tax credit with the adjusted gross income (AGI) threshold at $75,000 for single filers, $110,000 if married filing jointly, and $55,000 if married filing separately.
The rule of thumb for reducing your tax is to lower your taxable income so you can get a lower tax rate. With a lower taxable income, you may also be able to qualify for more tax credits. There are some other ways to further reduce tax, such as making a donation to charity. Check out IRS credits and deductions for individuals for more information.
(Updated in 3/2020)