2018 brought a lot of events to digest and could have allowed you to have the best year of your life, rebound from losses, or making some life changes. No matter your circumstance, a goal you should have is to realize tax savings by taking advantage of some proven year-end tips to reduce your taxable income. Let’s dive in!
Be Sure to Take Last-Minute Deductions
When you prepare your annual tax return, you must tally all available sources of taxable income to arrive at your gross income. From here, you may deduct the greater of either your standard deduction (shown in the table below) or your itemized deductions.
|Filing Status||2020 Tax Year||2019 Tax Year|
|Head of Household||$18,650||$18,350|
|Married, Filing Jointly||$24,800||$24,400|
|Married, Filing Separately||$12,400||$12,200|
Tax reform in 2018 dramatically increased the standard deduction to simplify the tax return process. If you don’t have enough deductions to overcome the high hurdle, it means you spend less time filling out your return.
However, if your deductions exceed the standard deduction, you will want to take advantage of last-minute deductions before the year ends. Doing so will lower your tax bill.
For example, if you receive a medical bill that isn’t due until 2019 but it can be paid in 2018, you might consider paying it now if it gives you more tax savings to take against your taxable income.
You can also accelerate a payment on a property tax bill due early in 2019. The same is true for an estimated state income tax bill due January 15. By paying bills like this due early in the new year but paid in the 2018 tax year, you can claim them as deductions against your 2018 taxable income and receive tax savings.
However, accelerating deductions could be a mistake if you find yourself subject to the alternative minimum tax, discussed more below.
Many people miss out on opportunities to take advantage of itemized tax deductions vs. the standard deduction. It is more than likely you will not itemize your deductions for 2018, however, they are still worth tracking. Allow TurboTax to figure out whether you should itemize or take the standard deduction.
If you find yourself on the borderline, your year-end strategy should focus on bunching your deductions. This means you should time your expenses to produce lean and fat years.
If you can control your timing, you should fit as many deductible expenses as possible into the year in order to surpass the standard deduction threshold. This will get you a larger tax deduction and save you valuable dollars come tax time.
In your lean years, you fall back to the standard deduction amount and attempt to accumulate as many qualifying deductions as you can until your fat years.
As I mentioned above, taking last-minute deductions can be wise unless it comes back to bite you with the alternative minimum tax (AMT). Taking too many deductions can inadvertently activate the AMT.
The AMT originally came into being as a way to make sure wealthy taxpayers don’t use too many legal deductions to drive down their tax bill to unreasonable levels. However, with time, more and more middle-class people have become affected by it.
The AMT is a calculation done separately from your regular tax liability and comes with different rules. Of the regular tax bill calculation and the AMT math, you must pay the higher of the two.
This becomes a year-end issue because certain deductible expenses under regular rules cannot be deducted under the AMT. This makes accelerating certain deductions a bad idea.
Some examples of these are state and local taxes (SALT) like income and property taxes. The recent tax reform placed a $10,000 annual cap per household on these items. If you expect to be subject to the AMT in 2018, do not pay the installments due in January 2019 in December 2018.
Using TurboTax will be a useful way to figure out if you’re be subject to the AMT in 2018. TurboTax offers a Deluxe software version which will help you determine the applicability of the AMT. If you use the affiliate link, you can save $20 off the retail price.
3. Buy Low, Sell Low
It’s highly likely you’ve got a few investments which are lower are because the Fed still needed to learn how interest rates affect inflation and caused us to miss the Santa Claus Rally. That doesn’t mean you can’t use these losses to keep the tax man away!
To find more tax savings from your losing investments, you need to sell them to offset any capital gains you’ve recognized during the year. Alternatively, you can deduct up to $3,000 in capital losses against your taxable income.
Any excess will carryover indefinitely either to (1) offset future gains you may recognize or (2) $3,000 of future taxable income per year until you’ve exhausted your loss. Also be mindful of whether you disposed of Section 1231, 1245, 1250 property used in a trade or business.
4. Contribute the Maximum to Available Retirement Accounts
If you’ve read any of my content, you know we learned how to save money in order get the most out of life. By contributing the maximum to your traditional retirement accounts each year, you can receive some tax savings by reducing your taxable income.
This allows you to build your nest egg for when you eventually reach retirement age. Whether you contribute to a Traditional 401(k) or Traditional Individual Retirement Account (IRA), you can take a deduction dollar-for-dollar against your taxable income up to $18,500 (401k) and $5,500 (IRA) in 2018. If you’re 50+, you can contribute an additional $6,000 or $1,000, respectively.
But be prepared to take advantage of 2019’s new retirement plan limits. Also, if you are self-employed and contribute to SEP IRAs, you can deduct up to 25% of your compensation, or $55,000 for 2018.
You can make eligible contributions for the 2018 tax year through April 15, 2019.
5. Avoid Paying the “Kiddie Tax”
In order to prevent Mom and Dad from shifting their investment income to their children to hide gains, Congress created “kiddie tax” rules. This makes any income earned by children taxable at a higher tax rate than they otherwise would as a non-dependent.
In 2018, the kiddie tax applies to any investment income received by the child in excess of $2,100. Investment income can come directly from investments held in the child’s name or the parents’ for the benefit of the child. Income earned above the threshold is taxed at the same rates as trusts and estates, which are typically higher than those for individuals.
If the child is a full-time student who provides less than half of his or her own support, the tax usually applies until the year the child turns 24.
Be mindful of the tax implications for any gifts given to children to pay for college tuition. If the gains on the stock are too large and the child has unearned income above $2,100, the earnings could be taxed at the higher rates reserved for estates and trusts.
It’s not a well-kept secret healthcare costs have risen faster than wages for many years. To protect their bottom lines, many employers have shifted the burden of paying for healthcare to employees. This trend has led to higher deductibles and lower coinsurance rates.
Essentially, employees fortunate enough to have health benefits offered through their employers are paying more for less coverage. Even worse, it doesn’t appear as though this trend will abate anytime soon.
Some high deductible health plans, or those with a higher incentive to forego healthcare because the insured pays full freight until reaching the policy deductible, come equipped with access to a health savings account (HSA). These accounts offer a tax-advantaged method of saving for healthcare-related costs.
In effect, participants save pre-tax dollars and allow them to grow tax-deferred until needed for medical treatment. At withdrawal, qualified healthcare expenses can be paid with funds set aside in an HSA.
Individuals can contribute up to $3,450 and families can contribute $6,900 post-tax and deduct them against your taxable income at tax filing time.
7. Use Any Remaining Funds in Your Flexible Spending Accounts (FSAs)
Flexible Spending Accounts are another source of tax-advantaged funds you can use toward qualifying medical expenses. The difference between FSAs and HSAs are the funds kept in an HSA rollover indefinitely, whereas funds left in the FSA qualify for the infamous “use it or lose it” rule.
Many employers offer these FSAs as a way to help employees pay for medical expenses which crop up during the year. Employees set aside money into these special accounts throughout the year but have access to the funds from the first day of the year.
In other words, if you choose to set aside $1,000 in your FSA for 2018, you can use the entire balance from January 1, 2018 but make equal payments toward the account throughout the year. However, any unused amount is forfeit at the end of the year.
Like HSAs, the money avoids both income and Social Security taxes. That makes these funds a great way to fund medical expenses throughout the year if you can target the correct amount to set aside.
With year-end approaching, check to see if your employer has adopted a grace period permitted by the IRS, which allows you to spend unspent 2018 FSA funds as late as March 15, 2019.
If not, you can always make some last-minute trips to the drug store, dentist, or optometrist and use up any funds left in the account. Don’t lose your hard-earned money!
8. Donate to Charity
The holiday season is upon us and with it comes your ability to contribute to the qualified charity of your choice. This is a great time to pull your spring cleaning ahead and empty out those closets of any no-longer needed linens, clothing, shoes, household goods and anything else you can think of to donate.
There are a number of qualified charitable organizations who would love to take these items off your hands. In exchange for some newfound room in your home, you also find some tax savings and get a deduction to count against your taxable income.
You can also count monetary donations made to a qualified charitable organization. And any volunteering you do for an organization can have mileage driven to and from the activity qualify for a $0.14 per mile deduction. It might not be much, but it is something to keep in your back pocket come tax time.
TurboTax will provide a calculator to value and track your donated goods and mileage driven for volunteering. It’s got quite a handy set of tools to help you tackle your annual tax return.
9. Take a Class to Improve Your Career
Are there any skills you’re in need of to further your career? Have you been on the fence about whether you should enroll in a class to pick up these necessary career advancement items?
Tuition payments towards a course which teaches you new skills can qualify as a tax deduction against your taxable income. If you can, try to pay for next year’s tuition by December 31 of this year and you can see if you qualify for the $2,000 Lifetime Learning Credit.
10. Accelerate Deductions & Defer Income
In general, it’s always a good idea to accelerate your available deductions and defer your realized income. This produces tax savings by lowering your taxable income and gives you the advantage of using the time value of money to defer tax payments. This is the underlying advantage of using deductions like depreciation and is why it can be useful to know how to read MACRS depreciation tables.
If you are a W-2 employee with a wage and salary taxable income, if can be difficult to defer your taxable income because it comes at regularly set intervals. You may have some flexibility in deferring your bonus into the next year as long as your company allows you to pay year-end bonuses in the year following when you worked to earn the bonus.
If you are a freelance worker who primarily earns a living through side hustles and gigs, you have more control over your taxable income. For example, you can delay billings until late December and ensure you won’t receive payment until the next year if you are a cash basis taxpayer. This method can help uncover some current year tax savings.
Deferring your side hustle income can also be a strategy used if you are a Form W-2 employee. However, it only makes sense to defer this income if you expect it to place you in a lower tax bracket next year. You don’t want to defer taxable income for additional tax savings this year if it pushes you into a higher tax bracket next year.
TurboTax Is Here to Help
I’m a licensed CPA and love to avoid paying as much tax as possible. I make it a regular goal to set my W-2 withholding at the exact level where I receive nothing back each year come tax return filing time. I attempt to maximize my tax savings each year by using the tips mentioned above.
I see leveraging tax savings as the ultimate challenge because I don’t want to get a refund. Why do that? I don’t want to give the Federal government an interest free loan when the money is mine to begin with.
Each year, despite my CPA license, I still use TurboTax to prepare my tax return. Even if I keep on top of the deductions available to me, there are still so many minor deductions and intricate rules which might make me pause when filing out my tax return.
This year, TurboTax is offering a Free Edition which includes FREE preparation, FREE printing, FREE efiling for your simple tax return. The software checks to see if you qualify for tax savings by analyzing your tax return’s eligibility for over 350 available tax credits and deductions.
I strongly suggest using this software to prepare your annual tax return because it simplifies the entire process and maximizes your tax savings opportunities. It removes the dread come tax time because all you need to do is fill in the on-screen prompts and it will take care of all the heavy lifting.
If you need a more powerful version, TurboTax offers a Deluxe version. If you use the affiliate link I have provided, it will save you $20 off retail.
And as a final tip, you better act fast because if you buy your TurboTax software before the end of the year, you can count the purchase as a deduction against your income.
About the Author and Blog
In 2018, I was winding down a stint in investor relations and found myself newly equipped with a CPA, added insight on how investors behave in markets, and a load of free time. My job routinely required extended work hours, complex assignments, and tight deadlines. Seeking to maintain my momentum, I wanted to chase something ambitious.
I chose to start this financial independence blog as my next step, recognizing both the challenge and opportunity. I launched the site with encouragement from my wife as a means to lay out our financial independence journey to reach a Millennial retirement and connect with and help others who share the same goal.
I have not been compensated by any of the companies listed in this post at the time of this writing. Any recommendations made by me are my own. Should you choose to act on them, please see the disclaimer on my About Young and the Invested page.