Your taxes may not officially be due until April 15th of the following year. However, there are steps you can start taking now to get prepared and possibly even reduce how much you’ll have to pay to the IRS. In this post, we’ll go through seven helpful tips you can use to make sure you’re getting your maximum return.
1. Contribute to an IRA
If you haven’t already, then you’ll definitely want to take advantage of contributing to an IRA (individual retirement account). Similar to a 401k, an IRA is a tax-advantaged investment plan that helps you to save and grow your nest egg. However, unlike your 401k, you can set up an IRA at any financial institution of your choosing.
The tax benefits you’ll receive from contributing to an IRA will depend on which one you choose. Here’s a quick overview:
- Traditional IRA – You’ll receive a deduction this year against your income. The money inside will grow tax-deferred and you won’t pay the IRS until you retire someday (after age 59-1/2) and start making withdrawals.
- Roth IRA – You won’t receive the tax deduction this year. However, the money inside will grow tax-free and any withdrawals you make once you retire (after age 59-1/2) will also be tax-free.
There are specific income requirements for who’s eligible to use each type of IRA. You can check them out here on the IRS’s website. All 2021 contributions have to be made before April 15th 2022.
2. Qualifying for Deductions and Credits
Do you have a child in college? Own a small business? Recently make energy-efficient improvements to your home?
Every year, the IRS offers taxpayers dozens of ways to qualify for federal tax deductions and credits. Both are helpful because they do the following:
- Deductions decrease your adjusted gross income, which means you’ll ultimately pay fewer taxes.
- Credits reduce the amount of taxes you owe dollar for dollar. If it’s a refundable credit, then you may even earn some money.
For a complete list of all the currently available deductions and credits, click here. I’d also highly recommend speaking to a tax professional since they will be the most qualified at helping you to understand which ones you can use.
3. Sell Your Losing Investments
No one likes when their stocks or funds do poorly. But from a tax perspective, they can provide some benefit through a strategy called tax-loss harvesting.
If you’re confident that your investments will not recover, then you can sell them at a loss. These losses can then be used to offset any capital gains you owe, thus lowering your tax bill. If your losses were significant, you can carry them into future tax years.
4. Spend Your FSA
FSAs or flexible spending plans are tax-advantaged savings accounts designed to help with medical and dependent care expenses. Effectively, you make tax-free contributions to the FSA and then reimburse yourself as qualified purchases are made.
The caveat, however, is that an FSA is a “use it or lose it” system. You’ll want to make sure that you use all the money you’ve contributed to the plan before it’s no longer accessible. To see what’s considered a qualified expense, check out this list here.
While this tip won’t directly lower your federal tax bill, it is an important and often forgotten way to make sure that you don’t lose the money you’ve contributed to the FSA.
5. Make a Donation
People who regularly make charitable donations can use their generosity to offset their federal tax bills. Most donations can be used as a deduction to offset your taxable income as long as they are considered “qualified” by the IRS. This usually includes donations to recognized charities and can be in the form of cash, gently used items (such as used items to Goodwill), and even securities (such as stocks).
Usually, to claim the bulk of these donations, you’d have to itemize your tax deductions instead of taking the standard deduction. However, under the CARES Act, donations made in cash can be claimed as a deduction of up to $300 for single filers and $600 for joint filers in addition to the standard deduction.
6. Make Your Estimated Tax Payments
If you’re self-employed or make a sizable amount of money from side hustles, then don’t forget that it’s your responsibility to pay the IRS the taxes you owe throughout the year. This is generally done through ES or estimated tax payments made once per quarter leading up to the end of the tax year.
If you have this type of income, it’s important to make your ES payments on time and in full before filing your federal and state returns. Not only will help make it so that you owe fewer taxes at the end of the year, but more importantly, it will save you from potentially being charged interest and penalties for underpayment.
ES taxes can be calculated using this worksheet here. However, it may be best to work with a tax professional who can help you to more accurately determine how much they should be.
Depending on how much of this type of income you earn, these tax payments could be very significant. Be sure to use an app like Buxfer to plan them into your budget so that you’re sure you’ll be ready to pay them as they come due.
7. Contribute to a SEP IRA
Another thing to consider if you’re self-employed or have side hustle income is that you can contribute to a retirement plan and reduce your taxable income. Among the three options, you may find that a SEP IRA is the easiest one to use.
Don’t confuse a SEP IRA with a traditional or Roth IRA. There’s a special rule that says that since you’re basically both the employer and the employee, you can contribute up to the lesser of $61,000 or 25 percent of your net earnings. Depending on how much that is, it could end up shaving thousands of dollars off of what you owe the IRS.
Keep in mind that this contribution can be in addition to your normal IRA and 401k contributions. For more about SEP IRAs, check out this article here.
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