4 Strategies to Reduce Your Taxes

March 16, 2015

Connect Member

Personal financial trainer helping women business owners gain control of their finances.

jenturrell.com

Taxes are one of the biggest payouts of our lives. The amount varies depending on factors like tax bracket, property ownership, and spending habits, but when you combine state and federal income tax with Social Security, Medicare, self-employment tax, property tax, and sales tax every year, it adds up to a significant amount.

The bottom line? You are spending more on taxes than you’d probably like.

Here are some strategies you can use to help ensure you’re keeping more of your money by legally avoiding taxes:

1. Invest in Tax-Advantaged Retirement Accounts

By contributing to your retirement account (401(k), Roth IRA or Roth 401(k), Traditional IRA, or SEP-IRA), you can get one of two tax advantages. Either invest pre-tax dollars now and pay income tax in retirement, or invest after-tax dollars now and never pay taxes on growth or payouts in the future.

In simple terms, here are the details:

Roth IRA or Roth 401(k)s

These accounts are funded with after-tax dollars. You won’t save tax money right now, but your money grows in the account, compounding over the years. When you retire, you won’t have to pay another dime of taxes on it.

It is also easier to withdraw the principal amount from a Roth IRA for certain life events. There may be a few stipulations, but if you need a down payment for a house or have medical difficulties, you won’t have to pay early withdrawal fees or taxes because you already paid taxes on the principal. The best time to use a Roth IRA is when you are in a lower tax bracket and assume you will be in a higher one in the coming years. This is because of the income limits on Roth IRAs and the immediate tax advantages offered by the Traditional IRA structure, which will probably benefit you more in a higher tax bracket.

In 2015, married couples filing jointly who earn up to $183,000 and single people who earn up to $116,000 can still contribute to a Roth IRA.

Traditional IRA, SEP-IRA, Solo 401(k)

These vehicles put your pre-tax dollars to work. That means you are paying yourself before you pay Uncle Sam, giving you a smaller tax bill than if you didn't contribute. These pre-tax dollars grow and compound inside of the IRA. Then, when you retire and start withdrawing from the account, you pay income tax on the distributions.

While many people assume retirement brings a lower tax bracket because they will not have income from their job, it is important to consider that you will probably no longer have young children as dependents and, hopefully, will no longer be paying a mortgage, which may currently give you mortgage interest deductions. So your tax bracket may not be as low as you think. You will also need enough income from your retirement accounts to pay for your lifestyle. Personally, I hope mine will not be reduced from my current lifestyle — I'd like to retire in style.

There is also no way to accurately anticipate whether taxes will go up or down in the future, but considering that taxes are at a lower level than they have been in the past, and taxes are the way the government raises money to operate and pay off its debts, it is probable taxes could go up. This is one of the main reasons many people take advantage of the opportunity to convert Traditional IRAs over to Roth IRAs. You will have to pay tax on the money the year you convert it, but afterward, the money and its gains will never be taxed again.

Don’t forget: You can contribute to a retirement account for the previous calendar year all the way up to the April 15 tax filing deadline, so if you didn’t get it done before the end of the year, you still have a chance to do it now!

2. Donate to Qualified Organizations

Donating to certain nonprofits is another way to reduce taxes on earned income. Giving money to qualified organizations allows you to deduct the donation from your taxes.

Not only are you saving tax money, but also you’re making an impact on the organization and the people they help. Maybe even more important than the tax deduction is the feel-good boost you get when you’re helping people. I, frankly, don’t know anyone who doesn’t like the idea of helping others by doing the work they love. In this case, the line might not be direct (i.e., you’re not volunteering time), but it’s certainly just as necessary.

That’s a win-win in my eyes.

Charitable donations can be especially important if you are on the cusp of a new tax bracket or at the Alternative Minimum Tax rate, because giving can actually bump you down to a lower tax rate. If you’ve never looked into how this can work for you, check out the IRS link to information on these donations and the organizations that qualify for them.

3. Maximize Tax Credits and Deductions

It is good idea to consult your accountant or tax professional on all of these strategies to use those best suited to your situation, but I recommend it most strongly when it comes to maximizing tax credits and deductions. I don’t ever want you to cross the line from using totally legal tax avoidance strategies to actually evading taxes, which is totally illegal and punishable by jail and fines (just ask Al Capone).

Tax credits are the better of these two options in terms of their impact on your taxes. A dollar’s worth of tax credits reduces your tax bill by the full worth of that $1 amount. A dollar’s worth of tax deductions, on the other hand, reduces your tax bill by the percentage amount of your marginal tax bracket. So that $1 deduction is worth $0.35 if you are in the 35 percent bracket and only worth $0.25 if you are in the 25 percent bracket. If you have any expense that could be claimed as either a tax credit or a tax deduction, go for the tax credit. However, because tax credits are so awesome, they are usually only available in certain, narrow circumstances, and the procedures used to calculate business tax credits can be complicated. Be sure to consult a tax professional.

4. Time Income and Expenses

If you are a small business owner, there is one more way to adjust your taxable income for the year. You can delay income payments (either by agreement with the payee or by sending invoices out in the new year) and increase business expenses in the current year, thus lowering your taxable income. The main reason for doing this is if you have had a high income year this year and expect less income the following year. This strategy is most successful when you are on the edge of a higher tax bracket and delaying invoicing and accelerating expense payments will bring you down into the lower tax bracket.

If the opposite is true, and you know that a large project is coming up the following year that will bring in far more income than this year, you will want to take the opposite strategy. Push for payments before the end of the year on all income possible and delay large expenses so they can be used as deductions against the higher income the following year.

These techniques can help you lower your tax bill and keep more of your earned money where it belongs — in your pocket. The truth is, even though we all appreciate having roads and public services, there aren’t many people who love paying taxes.

While there isn’t a magic wand you can wave to become tax-free, there are a number of ways to lower the taxes you owe, or even drop down a tax bracket. And that means minimizing the negative guttural reactions we have to giving our hard-earned money to the government each year. 


Jennifer Turrell is a member of the DailyWorth Connect program. Read more about the program here.

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