Unless you filed for an extension on your 2021 taxes, by now you know what your total tax bill was for 2021.
Like many, you saw an increase from the year before and you might be wondering if there is anything you can do going forward to minimize that tax liability.
As Arthur Godfrey once said, “I’m proud to be an American and pay taxes but I could be just as proud for half the money.”
There are several things one can do to lower their tax burden. I’m listing the five most common (If these don’t apply to you, feel free to reach out to me and we can discuss some alternatives).
#1. Contribute money into your 401k or other retirement plan at work
For the 2022 tax year, one can contribute up to $20,500 (Up to $27,000 if one is 50 or over) into their 401k or 403b.
If making pretax contributions into your plan, these lower your taxable income and therefore lower your taxable income.
Many plans today have an option to make a contribution into the Roth portion. This has no impact on lowering your taxable income now, however, it allows for tax free growth and unlike a traditional 401K, has no requirement for distributions later on and lastly, if you take money out of the Roth 401k, no taxes are due.
Rick’s Tip! Work with your tax preparer or Certified Financial Planner practitioner to determine if it makes sense to contribute a certain percentage to the Roth 401k (403b) side. Even though there may not be an immediate tax benefit now, the option of tax-free growth and tax-free withdrawals might be compelling.
#2. Contribute money into a deductible IRA
If one Is under 50, the maximum one can contribute in 2022 is $6,000 ($7,000 if over 50). There are guidelines whether one can deduct the contribution if one has a retirement plan at work. There are also rules if your spouse has a retirement plan at work.
Rick’s Tip! If you are eligible to make an IRA contribution and you file jointly and your spouse doesn’t have earned income, you can make a contribution into their IRA. The same rule applies for Roth IRA’s. Much like the Roth 401K, there is no tax deduction now, but it does allow for tax-free growth and tax-free distributions (Assuming certain rules are met).
#3. Contribute to a Flexible Spending Account (FSA)
If your employer offers an FSA, this can be yet another way to lower your tax burden. Let’s say you think your out-of-pocket medical expenses will total $6,000 this year. You can set aside from your pay (on a pre-tax basis) up to $2,850 toward these medical costs. If you file jointly and your spouse has an FSA at their job, they can also put in up to $2,850 for 2022. Kid needs braces?, you need prescription glasses?, have a co pay coming up? These all are eligible expenses.
Rick’s Tip! Since money left in an FSA at year end is subject to forfeiture, it is best to not max this out unless you know you will have bills that exceed the amount you put away. If December 31st is approaching and you haven’t emptied out your account, you can stock up on things like masks or hand sanitizer and chiropractic or acupuncture, counseling, contraceptives, hearing aids, and even orthotics.
Rick’s 5-star Tip! If you have a High Deductible Health Plan, you may be eligible to contribute to a Health Savings Account or HSA. This allows one to put away up to $3,650 ($4,650 if 55 or older) and for a family, $7,300 or ($8,300 if 55 or older).
HSA’s give one the unique ability to deduct the contribution, allows for tax-free growth, and lastly, if used for qualified expenses, the money comes out tax-free. Also, unlike an FSA, there is not the same time limit on when the money has to come out. An HSA allows one to invest these contributions for potentially decades before taking the money out.
#4. Tax Loss Harvesting
If you bought a stock, stock or bond mutual fund or ETF, and 12 months or more has passed and the value of this investment has decreased, you can sell up to $3,000 of losses and deduct that from your ordinary income. The other option is to offset a gain with a loss.
Let’s say 13 months ago you bought two stocks. Stock A for $8,000 and Stock B for $6,000. Now, Stock A is worth $4,000 and Stock B is worth $10,000. If you sold both stocks, it would come out to a net zero. No gain and no loss. (If you wanted to keep Stock B, you could just sell Stock A up to a $3,000 loss, and take the loss off of your ordinary income).
There are rules when taking a loss. One being, you can’t buy that same investment (or identical) within 30 days without being subject to the Wash-Sale Rule.
Rick’s Tip! To learn more about Tax Loss Harvesting, give us a call or check out this article HERE
#5. If making a charitable donation, do it in the most tax advantaged way
If one is gifting a somewhat small amount to a charity, writing a check works fine. However, when making a sizeable gift, there can be better ways to give.
- A Qualified Charitable Distribution (QCD) allows one that is over 70 ½ to make a contribution from their IRA and therefore, avoid paying tax on the distribution since the gift goes directly to the charity. There is a certain protocol in making these gifts so please check with us or your CPA before doing this.
- A Donor Advised Fund (DFA) allows one to contribute a large amount in one tax year to a DAF and then dole it out as you see fit to as many charities as you like. This strategy allows you to deduct quite a bit of income in one year while staying true to how you want to gift over time.
When might one utilize a DAF? Let’s say Mortimer receives a large bonus of $300,000 from his job. This bonus is subject to ordinary income taxes and most likely is putting him into a higher tax bracket. By establishing a DAF and donating a large sum into it for future gifts, this can help offset income and thereby reduce his taxable income for the year.
Rick’s Tip! Once money is put into a DAF, it cannot come back out. Determine carefully if a DAF is right for you and how much you want to contribute. Since contributions can be made ongoing, if unsure, it may be best to donate in stages.
Here is a previous blog article on the topic: Are Donor Advised Funds Right for You? 4 Key Tax Advantages.
Feel free to reach out to me if you have any questions. I’m here to help.
Want to schedule a quick complimentary call with me? Click HERE to see my online calendar
Click HERE to receive our award-winning newsletter. You can unsubscribe at any time
All the best.
Rick Fingerman, CFP®, CDFA™, CCPS®
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.