5 Ways to Reduce your Tax Liability by Bahaa Abu-Ghalia
“It’s income tax time again, Americans: time to gather up those receipts, get out those tax forms, sharpen up that pencil, and stab yourself in the aorta.” – Dave Barry
JK. Although, it does feel that way. People tend to cringe whenever they hear the “T” word to them. I’m talking about ta- ta- ta- TAXES. That was even hard for me. As a tax preparer, you see it all and hear it all. You get the happy clients who receives a fat refund check from the IRS and on the other hand, you have clients that are faced with an unexpected huge tax bill because there was no tax planning and they weren't prepared.
While tax avoidance isn’t a viable option, deductions and credits are the two words every taxpayer loves to hear. To help prepare you for your 2017 tax returns, I give you 5 effective ways to reduce your tax bill.
1. Fund Your Retirement Account
This is probably one of my favorite tax breaks that I encourage everyone to do. When you fund an IRA, SEP, or 401k; you can deduct the amount from your income up to the maximum limits. For 2017, you can contribute $18,000 in a 401k and $5,500 into an IRA. If you’re 50 years of age or older, the limits increase to $24,000 and $6,500, respectively. The self-employed may contribute the lesser of $52,000 or 25% of your income into a SEP. That’s right you get to save money by SAVING MONEY. Not only that, some taxpayers qualify for the Retirement Savings credit which can reduce their taxes by up to 50% of the first $2000 contributed. For more info click
2. Spend Money
And no, that doesn’t mean you should go on an extravagant shopping spree or that vacation to Paris you’ve been dreaming about. By spending money what I mean is to invest money into your business. It is never a bad idea to make purchases that will help grow your business. Perhaps your computer is outdated and you need a newer one with a faster processor and better security features? I like to think of making business purchases as getting huge discounts on major purchases. Let’s say you fall into the 25% tax bracket and a new computer you’ve been eyeing costs $2,000. After tax savings, you’re only paying $1,500 for it.
3. Reorganize Your Business
As a small business, it is important that you talk to your accountant about how you should organize your business. The simplest method, which is used by a majority of the self-employed, is a Sole Proprietor. Although it’s simpler, it is more expensive for tax purposes. Therefore, I HIGHLY advise clients to create an LLC and treat your business as an S-corp.
The difference is that a sole proprietor not only has to pay income taxes on the net profit, they must pay 15.3% of it for FICA (SS and Medicare Taxes). As an S-Corp, you only pay FICA taxes on a portion you pay yourself as a salary deemed reasonable by the IRS. The IRS doesn’t elaborate on what they consider “reasonable”; however, I recommend a 40/60 Salary to distribution ratio. See below an example of how much you can save by reorganizing yourself. Numbers based on married filing jointly status (2014).
As you can see, even when you add the SS and Medicare tax you’ve paid throughout the year ($6,120 0n $40K salary); you will still save $6,352. See the examples below.
4. Pay attention to your investments.
Let’s say you bought 1,000 shares of ABC corp. at $4/share and a week later it sky rocketed to $10/share. You just made $6,000 without hardly lifting a finger. Your initial reaction will most likely be SELL! SELL! SELL!
Please consider your tax bill when selling stocks at huge gains. Since the sale of ABC corp. is deemed to be a short-term capital gain (investments held < 1 year), this will be treated as ordinary income and will be taxed at the same rate as your earned income. Long Term Capital Gains (held > 1 year) has a capped rate of 20% for those who fall under the highest tax bracket and those whose income is below the 25% tax bracket (<$37,950) pay NO capital gains tax on a sale.
Try selling one of your other holdings who might not be doing as well to offset your gains. For instance; say you bought 1000 shares of XYZ corp. for $15/share in the beginning of the year and the company reported a horrible 3rd quarter causing it to plummet to $10/share. Now you’re down $5,000 on paper from this bad investment. It would be a good idea to sell this before the end of the year to offset your prior gains. By doing so, you only pay taxes on $1,000 of income instead of $6,000.
5. Give Back
“If you’re in the luckiest 1% of humanity, you owe it to the rest of humanity to think about the other 99%.” -Warren Buffet
I take back what I said earlier, this is my FAVORITE tax deduction to utilize. You don’t have to be a one-percenter (1%) to make a difference. Any gift to charity will make a difference one way or another whether you donate $1,000,000 or $100. Do some research on local charities in your area and pick one that you strongly believe in and want to help make a difference. You can deduct up to 50% of your income from charitable contributions. Don’t feel bad if you don’t have the funds to donate, clean your closet out. Non-cash contributions are also deductible. The only thing you cannot deduct is time spent volunteering. For more info on this subject click here.
Remember to speak to your accountant before tax season so that you can be properly prepared and have a much smoother process than last year.
“Thinking is one thing no one has ever been able to tax.” – Charles Kettering