5 Tax-Reduction Strategies to Stretch Your Money
You work hard for your money, so it can sting when taxes take a big portion of it. These five basic tax-reduction strategies can help you keep more money in your hands.
Before making any moves, though, you should discuss these ideas with a tax professional to determine whether one or more are appropriate for your specific tax situation.
1Make the most of retirement contributions
Workplace-sponsored 401(k) plans can help you save for retirement while lowering your tax liability, as these accounts are funded with pre-tax dollars. In the 2022 tax year, you can contribute up to $20,500 to a 401(k) plan, plus $6,500 if you're 50 or older by the end of the year.
If you don't have a 401(k)—or if you want to save even more for retirement—you might be able to reduce your taxable income today by contributing to an individual retirement account, or IRA.
If neither you nor your spouse is covered under a retirement savings plan through an employer, you can deduct the full contributions you make to a traditional IRA up to the annual limit—which is $6,000 for 2021 and 2022—plus another $1,000 if you're 50 or older.
Your contributions can apply to the current tax year. They can also apply to the previous tax year when you make them before the tax-filing deadline and choose to apply them to the prior year. For example, a contribution made between January 1, 2022, and the April 15, 2022, filing deadline can apply to the 2021 or 2022 limit, depending on which you choose.
Be careful, though—your ability to deduct traditional IRA contributions might be limited if your employer offers a retirement plan and your income is considered too high, as measured by your modified adjusted gross income, or MAGI. For example, for the 2021 tax year the MAGI limit is $76,000 for single filers and $125,000 for joint filers who are both eligible to contribute to plans at work. If only one joint filer is eligible for a work plan, the income limits are somewhat higher for the other. Talk with a tax professional to determine the amount you may be able to deduct.
2Give to a qualified charity
If you donated cash to a charity in 2021, you may be eligible to deduct the amount, even if you typically take the standard deduction. The IRS explains that for those who take the standard deduction, individuals filing separately may be eligible to deduct up to $300 more for cash contributions made to qualifying charities in 2021, whereas married couples filing jointly can deduct up to $600. Certain exceptions apply.
If you itemize, charitable contributions made in cash can also help lower your tax liability. Typically, the limit of what you can deduct is 20% to 60% of your MAGI, and it varies based on the contribution type and the charitable organization. However, for donations made specifically in 2021, you can apply an increased limit and elect to deduct up to 100% of your MAGI. Again, it's best to consult a tax professional for details.
3Understand the tax implications of investments
The investments held in your stock portfolio for more than a year may be subject to a lower capital gains tax rate after selling than those you held for less than a year. In addition, if your investment sales for the year show a net loss, you can carry the loss forward and use it to offset up to $3,000 in ordinary income each year until the loss is recovered with tax deductions.
For example, if you lose $12,000 on the sale of a stock, you could deduct up to $3,000 from your taxable ordinary income every year for 4 years. Or you could use the full $12,000 loss to offset gains in any tax year, which will reduce your capital gains tax for that year.
4Calculate which deduction strategy makes sense
For the 2022 tax year, individual filers will qualify for a standard deduction of $12,950, which is up from $12,550 in 2021. Married couples filing jointly will get a $25,900 standard deduction in 2022, which is up from $25,100 in 2021. However, if you've kept careful financial records, have proof of your expenses and are willing to do some math, you may find itemizing to be a more advantageous option.
The IRS doesn't limit the number of itemized deductions you can have, so this option may result in far more money than the standard deduction. This is especially true if you've had a year with higher-than-normal medical and dental expenses, paid significant sales or property taxes, or had expenses in several other categories that can be itemized.
5Prepare for current and future education costs
Support your family's educational goals and benefit from tax advantages with a 529 college savings plan, which allows funds to be used for qualifying higher education expenses. In some states, these funds can also be used for qualifying expenses related to attending a K-12 private school.
If you have children or grandchildren, these plans offer a tax-advantaged way to contribute to the costs of the recipient's education while avoiding gift tax. SavingForCollege.com explains that for the 2022 tax year, up to $16,000 in contributions made to an individual's 529 savings plan could qualify for the annual gift tax exclusion, or up to $32,000 for contributions by a married couple filing taxes jointly.
Depending on the state in which you live and the state in which the plan is held, there could also be state-level tax advantages for 529 plan contributions. More than 30 states currently offer full or partial deductions for 529 plan contributions.
If you want help making the most of your income, talk with a tax specialist. They can discuss tax-advantaged strategies designed to help keep more of your money working harder for you.
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