It’s almost the end of the year, which means you might be a little curious about next year’s taxes. If you received a raise this year, had a change in marital or family status, or run your own side business, you may also be wondering how to reduce your taxable income to not owe as much in April.
Lucky for you, I love to plan ahead of time. In this case, months ahead of the April 15, 2016 tax deadline. Every year, I try to reduce my taxable income as much as I legally can. After all, no matter what you think of them, you can probably think of better ways to use your money than by giving more of it to the federal government.
In the spirit of reducing your taxable income so you can put your money to things you enjoy, here are 5 ways to reduce your taxable income legally.
Know What You Might Owe
One of the best ways to prepare yourself for tax season is to understand your current financial status. Try to estimate your taxes by preparing your tax returns using all the information you have right now. You may need to estimate some numbers, but you can base a lot of the unknowns on previous year’s taxes, unless your status changed dramatically (multiple new children, a new job going from a teacher to a Wall Street banker, etc.)
Knowing what you owe will help you decide on a strategy now to reduce your taxable income. If you work with a tax professional, they may also be able to guide you in determining the best avenues to take to reduce your taxes.
Supercharge Your Retirement Savings
If you’ve been putting in the minimum in your retirement savings accounts and just coasting through the process, it’s time to supercharge your savings to reduce your taxable income. Increase your 401(k) contribution as much as you can afford, making sure not to go over the $18,000 contribution limit for 2015.
Already maxed out your 401(k), or don’t have one? Contribute to your Traditional IRA, up to $5,500 this year. You can also contribute to your Roth IRA, but you won’t see any tax breaks for it up front. While you have until April 2016 to contribute to your IRA, the sooner you put money into your IRA, the more time it has to grow tax-deferred. Saving for retirement and reducing your taxable income? Win-win!
Save for Future Health Expenses with Your HSA
One of Harry’s (and now mine) favorite investment vehicles, you can contribute $3,350 as an individual and $6,650 as a family to your HSA. Best part? Your savings helps to reduce your taxable income!
In addition to reducing your tax burden, you’ll also be saving for future medical expenses. Medical care is only projected to get costlier, so it’s nice to start seriously saving for it while you’re young! I also love HSAs for their portability and flexibility. With your HSA, all of your investments go with you, even if you leave your job. There’s also no spending requirement by the end of the year like there is with a flexible savings account.
Give to Charity
Another one of my favorite ways to reduce taxable income is giving to charity. Now, in many cases your charitable giving does need to be paired with some other deduction, like student loan interest or home mortgage deduction, but this doesn’t mean you should neglect charitable donations to reduce your taxable income.
If you’re already planning on donating this year, and you’ve planned ahead to determine how much you may owe in April, consider donating a little more to reduce your overall taxable income. You may find that, including other itemized deductions, your charitable deduction will save you more money than taking the standard deduction. This way, you’re helping out your favorite charity (or your kid’s school, etc.) and reducing your taxable income!
Paying for Childcare
Speaking of kids, if you have children in daycare, you may want to consider paying your child care expenses with pre-tax dollars. Some employers offer flexible spending accounts with dependent care, allowing you to save up to $5,000 for childcare (including daycare, but not babysitting).
While daycare around the country generally costs much more than $5,000 a year, saving $5,000 pre-tax and spending it on your child’s daycare or other approved expense is definitely a good way to reduce your taxable income – if you have a kid, of course. This plan doesn’t yet apply to pets 🙂
Of course, it only makes sense to defer income if you think you will be in the same or a lower tax bracket next year. You don’t want to be hit with a bigger tax bill next year if additional income could push you into a higher tax bracket. If that’s likely, you may want to accelerate income into 2015 so you can pay tax on it in a lower bracket sooner, rather than in a higher bracket later.
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There are still many ways for you to reduce your taxable income this year. It’s not too late to increase retirement contributions, stash away more money in your HSA, or even increase your flexible spending account (as long as you make sure to spend it on time). Are you trying to reduce your taxable income, and how do you plan to do so this year?