Now that the crush of tax season is over, here are some powerful things you can do now and throughout 2018 to reduce your future taxes. These tips come from me and my partner Brian Lovett, CPA, JD…
Withholding. This year, more than ever because of the sweeping new tax laws, your withholding and estimated tax payments need to be managed. Use your 2017 tax return as a guide and prepare a projection of your 2018 income tax. Then compare the corresponding projected numbers to your current withholding and/or estimated tax payments and adjust both as necessary so you will come out fairly even when your tax returns are filed next April. Smart: Redo this process in October, and if necessary make further adjustments at that time so you don’t end up with a big tax bill or a big tax refund next year.
Amended returns. This is not a usual step, but if you noticed anything that could be amended on your 2015 or 2016 (or even your 2017) return that would result in a refund, you should consider filing an amended return. The time window for amending these years’ returns is still open. If you had an extension for your 2014 return, that time window might also be open, but for this you have to act quickly. Some things that might result in a refund, besides to correct errors, would be an election to forgo qualified dividend treatment if you had investment interest deductions that are carried forward…if you sold your residence and did not claim the $250,000 or $500,000 capital gains exclusion or if you were legally separated or divorced and did not take an extra $250,000 you might have been eligible to claim…or if you over-reported interest or dividends from a prior year’s 1099 that was mixed in with your 2017 tax data.
Financial planning guide. Your tax return can be an effective guide to your investment income, and with little effort it could lead to retitling some assets or reallocating your assets between individual names and your tax-deferred accounts. An easy way to get a quick overview is to lay out side by side your returns for the past three or four years and review your sources of income and deductions. You might then, for instance, consider reducing high mortgage interest by using some money in low-interest-earning savings or money market accounts…or reducing your overall investment income by replacing tax-free municipal bonds in taxable accounts with stocks and replacing stocks in tax-deferred accounts with higher-yielding corporate bonds.
Retirement accounts. If you maximized contributions to tax-deferred retirement accounts last year, good for you. If you did not, you should consider doing it this year. You can contribute tax-deductible amounts to a traditional IRA or 401k or a Keogh, SEP or solo 401k if self-employed…or you can make nondeductible contributions to a Roth IRA, solo 401k or traditional IRA. Also consider contributions on behalf of a nonworking spouse. It generally makes sense to make regular payments into such accounts throughout the year (or as much of it as possible) rather than waiting until the end of the year or just before you file your tax return the following spring. The sooner you contribute, the sooner the tax-deferred income starts compounding. If your employer offers a 401k plan and makes matching contributions, definitely try to contribute the amount needed to get the full match available. And while you are looking at your retirement account options, it’s a good time to recheck your beneficiary designations to make sure they are in order.
HSA, Section 125 cafeteria plans and other employer-sponsored pre-tax opportunities. If your employer offers a way to contribute some of your compensation on a pre-tax basis to a health savings account or to otherwise pay medical costs, consider the maximum salary reductions that would benefit you. It is too late to make these decisions for 2018, but some planning with your employer’s HR person can help you participate to the maximum extent you could benefit starting in 2019. These are “free” tax benefits that should not be wasted.
Declutter. Don’t let entropy make your job harder! Discard unneeded paperwork by shredding old tax records. Generally, our recommendation is that it’s fine to shred bank, brokerage and tax-reporting statements more than seven years old and receipts, bills and invoices and similar papers more than four years old. Warning: Information about your basis—what you paid for various investments and other assets—and related records should be retained as long as you hold those assets.
Simplify your investments. Some types of investments make your tax reporting so complex that they should not be held at all if they make up an insignificant portion of your total investible assets. These include, for example, publicly traded partnerships, hedge funds and foreign securities. The tax reporting statements such investments provide are usually delayed and make it much more difficult to prepare your tax return and, if you use a tax professional, more costly. Likewise, if you have a small position in a foreign bank account or are a signatory for convenience for your employer on such an account, consider terminating this account or that power. These require extra filings usually done along with your tax returns.
Itemized deductions. A tax projection, mentioned above, will indicate whether you could benefit from itemizing on your 2018 tax return or will take the standard deduction. It’s best to know this information throughout the rest of this year, if possible, so you can maximize the benefit either way. Take a look at this post on substantiating your deductions and this one on charitable donation strategies…and know that deduction planning is one area where it often makes sense to meet with a tax professional early in the year.
Specialized areas. There are some kinds of activities that are not terribly unusual but that still involve enough special tax wrinkles that you should make extra efforts to learn about them—and therefore save on taxes. These include having considerable capital gains stock transactions…substantial charitable contributions…real estate investing and management…self-employment income…investments in businesses you are not active in…and extensive investments in bonds or other fixed-income instruments.
Be better organized. Tax time is a chore for the best organized and a dreaded period for all others. Don’t fall into the latter category! At minimum, make a folder in a drawer or file on your computer, or both, to place in it what you receive that even might have a tax implication or need to be reported on your tax return.
Final thoughts. The above is a brief roundup of some easy and effective ways you can reduce your taxes and have a better understanding of your finances. There are exceptions to these methods and additional methods that can be used, of course—and it is always advisable to consult with a knowledgeable professional about your specific situation.