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On the Horizon

Thoughts, musings, and a little bit of entertainment from the world of personal finance.

Taxes

3/10/2019

 
Happy tax month!  Except for a couple accountant friends on the island, tax season is generally a giant pain.  But once they’re done, most people are thrilled to receive a tax refund - who doesn’t like free money, right?  

Consider the flip side of that coin, if you will: a tax refund really means that you loaned your money to the government last year at zero percent.  Actually zero, too, not the 0.01% “zero” your checking account earns. If you owe taxes, you got an interest-free loan from the government last year.  No credit check necessary!

At a high level, here’s how taxes work:  Start with gross income; subtract “above the line” deductions to get “adjusted gross income”; subtract “below the line” deductions to get “taxable income”; look up your tax in the tax tables; compare to how much you actually paid during the course of the year; done.

If you want a detailed list of all possible deductions, start with Wikipedia.  Then hit the IRS website, but have a hefty supply of your favorite caffeine source handy.  This article is not going to tell you why planting trees in your backyard won’t qualify for the reforestation expense deduction.  But it will give you a few broadly applicable suggestions to reduce future years’ tax bills.
1) Increase your Traditional 401(k)/IRA contribution

Contributions to a Traditional 401(k) or a Traditional IRA are tax deferred, meaning you pay no tax now but will at some point in the future when you withdraw the money (as opposed to a Roth, where you pay now instead of at withdrawal).  If you’re not maxing out your retirement contribution ($19,000 in a 401(k), $6,000 in an IRA for 2019) and have some excess savings lying around, consider bumping up that contribution to reduce your taxable income.

2) Max out medical savings contributions

There are three types of medical savings accounts:  FSAs (flexible spending accounts), HSAs (health savings accounts), and Archer MSAs (medical savings accounts).  Contributions are deductible or funded with pre-tax money to begin with - either way, it reduces your tax bill. Even better, as long as the funds are used on qualified medical expenses, what you spend is never taxed.  Never. So go ahead and max out these contributions, unless it’s to an FSA - be careful with FSAs, that money doesn’t roll over like HSAs and MSAs, which means you could lose it if you contribute more than you spend.

3) Timing

When doing taxes, you either take the standard deduction (a set amount) or you itemize your deductions.  The new tax bill bumped the standard deduction for a single filer to $12,000 from $6,350, meaning that it’s less likely you will benefit from itemizing.  But! Say you’re sitting at $10,000 in itemizable deductions come December and you give $3,000 per year to various charities. Why not use a year-end bonus to give next year’s $3,000 charitable donations this year?  That way you get to deduct $13,000 this year from itemizing and $12,000 next year (the standard deduction), saving yourself $1,000 in taxable income.

So there you go.  Reduce taxable income in future years by contributing to Traditional retirement plans and medical savings accounts.  Take a look at your itemized deductions around Thanksgiving - if you’re close to the standard deduction, see if there is anything from next year you can bring forward into December to get over that itemization threshold.  But for now, breathe a sigh of relief that it’s over, and go enjoy your tax day freebies on the 15th.

​

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