Tax Tips to Save More of What You Earn
It's often said that corporations don't pay anywhere near as much in taxes as individuals, and that the rich often have access to tax shelters that the working and middle classes can only dream of. How is this even possible? With the complications and intricacies of the United States tax code, there are many ways that high earners can reduce their tax liability and keep more of their income each year. These tips make it easier for people with moderate or higher incomes to maximize their tax deductions and find ways to get ahead financially.
Planning for Future Income
One of the most important keys to managing wealth is to plan for the long-term. Tax predictions don't always make sense if they are done one year at a time. Instead, experts suggest that people who need to balance possible tax deductions against higher income plan to claim deductions in the year where it will make the most impact. Deciding to maximize tax-deferred deductions, like retirement contributions, in a higher income year will reduce the tax liability to a greater degree than in a year with lower total income.
Maximizing Retirement Savings and Tax Deductions
Planning for retirement is a must for anyone who can't expect that Social Security will provide them any more than a supplemental income. The Internal Revenue Service makes it fairly easy to contribute to an employer's existing retirement plan. As of 2019, individuals under age 50 are allowed to contribute up to $19,000 per year to a 401k, 403b or 457 savings plan. If they make less than $118,000 filing jointly, their contributions can be tax-deferred or deducted from their taxes. People with a limited income may also have access to the retirement saver's credit, which permits a yearly credit of up to $1,000 on a maximum $2,000 in contributions.
Although contributing to a 401k is a very common method for people to plan for retirement, the use of an Independent Retirement Account (IRA) also carries some potential deductions. The maximum amount of the deductions depends on the person's income, filing status, and access to a retirement plan at their place of employment. However, many people are allowed to deduct up to $5,500 per year of contributions to a traditional IRA. People should carefully consider the benefits of contributing to a traditional IRA compared to a Roth IRA if they meet the income requirements for a Roth IRA. While contributions to a traditional IRA can be tax-deferred, they cannot with a Roth IRA. It is up to the person to decide if their tax burden is greater at the present, or if they would rather pay the taxes now and claim withdrawals from a Roth IRA tax-free after they retire.
When people start to increase income and generate some wealth, they need to think about the benefits of itemizing deductions. This is often how a lot of people are able to significantly decrease their tax liability. Although the mortgage interest deduction is common and possibly the best-known of the itemized deductions, there are others to factor in as well.
Mortgage Interest Deduction
When people buy a home, they spend the bulk of their mortgage payments in the first few years paying interest. This can be a handy tax break when homeowners need it most. With a few exceptions, buyers who obtain a mortgage to purchase a home to live in as a primary residence can deduct all the interest they pay, as long as the total mortgage balances are less than $1 million for a married couple filing jointly.
People who pay for their own health insurance premiums or who have a lot of medical expenses should consider tracking these expenses and claiming them as an itemized deduction. In order to claim the deduction, the expenses must exceed 10 percent of a person's adjusted gross income. Only the amount exceeding 10 percent can be claimed. People who have insurance provided through their employer may conclude that contributing to a pre-tax flexible spending account may help to minimize their tax liability without the same spending requirements.
Donations to charity, with some exceptions, might not be enough alone to justify itemizing expenses. When taken at the same time as the mortgage interest deduction, however, deducting the cost of money and goods given to charity might lower a persons' tax liability by a few-hundred dollars.
Taking Advantage of Favorable Rates on Capital Gains
Owning a business or selling property involves capital gains, which might be a very practical way to invest and save money on taxes. Selling a primary residence usually carries with it a capital gains tax exclusion of up to $250,000 for a single person, or $500,000 for a married couple filing jointly. Long-term capital gains taxes (on items held for at least one year, typically) are lower than tax rates on regular income. Putting money into an investment, business, or property and selling at an ideal time might lead to a lower tax liability on the income as a whole.
With greater income often comes a higher tax liability and a higher responsibility to manage your budget well, but that doesn't have to be the case across the board. By taking advantage of these tax tips, earners can find ways to put more of their income into practical use for the present and future while lowering their tax liability at the same time. Millennials don't have to be trapped financially: Here are a few tips to get ahead.