Congratulations on putting Tax Day behind you. I hope the sting of the “Tax Due” line on your returns wasn’t too bad, or better yet, you had a refund coming to you. But whether you owe or are owed by Uncle Sam is a function of how much you withheld or paid in relative to how much you needed to pay in taxes. The question shouldn’t be “Did I kick in enough to avoid having to pay more?” but rather, “How can I owe less next year, even if my income stays the same or goes up?” Our clients ask us that all the time, and often right around this time of year. And the facts are that too many CPAs aren’t analyzing their client’s behavior for ways to reduce tax liability, they’re just plugging in the income numbers, the deductions, and letting their clients know how much they owe. Here are a few ideas on how to reduce your tax bill.
1. MAXIMIZE CONTRIBUTIONS TO YOUR 401(K) OR 403(B) RETIREMENT PLAN
When you direct income from your paycheck to a qualified retirement plan, those contributions reduce your Adjusted Gross Income, which is the starting point for calculating tax due. Qualified retirement plan contributions come right off the top of your AGI, up to the maximum allowed contribution of $19,000/year for anyone under the age of 50, and $25,000 for those over 50. If you’re not maximizing plan contributions, that’s a good place to start to reduce taxes and save for retirement while you do it.
2. BUNDLE YOUR CHARITABLE CONTRIBUTIONS
With the new tax law in effect since January 2018, the size of the standard deduction has increased, setting much higher the bar to get over to make itemizing deductions worth it. But, clever planning of charitable contributions can make good tax sense. A number of our clients now use the standard deduction, where they might have used itemized deductions in the past, but they still have significant charitable giving activity. If you’ve got the assets available, grouping all your charitable giving for the next several years into one year for tax purposes can reduce your tax bill in the year you make the gift. How does it work? Many of our clients use an account known as a Donor Advised Fund (DAF) to bundle their gifts in one year. A DAF allows you, the grantor, to irrevocably gift assets into an account earmarked for charitable gifts. You control the investment of the account and can name any qualified charity you like as a beneficiary, while also deciding when to make the gift from the DAF account. This way, you can put perhaps three or four years’ worth of planning charitable gifts into the account all in one year, and get all the tax deduction for the gift in that year by itemizing, but spread the actual gifts out across the four years, and take the standard deduction in the other years.
3. IF YOU’RE A SMALL BUSINESS OWNER, CONSIDER A DEFINED BENEFIT OR COMBINATION PLAN
Owners of small businesses with few employees can often defer material amounts of their profit into qualified accounts by establishing what’s known as a combination (combo) plan. A combo plan combines a Defined Contribution (401(k) Profit Sharing) Plan and Defined Benefit Pension Plan. Depending on the number and age of the employees, the combo plan allows the owners to set aside substantial numbers of dollars in tax deferred accounts as long as they also make relatively smaller contributions to employees’ qualified accounts. Alternatively, a standalone defined benefit plan can often accomplish a similar effect. These qualified plan structures can be a huge help to small business owners looking to reduce their tax bill.
While other ideas like depreciating tangible assets like buildings and machinery, contributing to a Health Savings Account (HSA) if you have a high deductible medical insurance plan, or maxing out a tax deferred traditional IRA (if your income falls under the phase out thresholds) can also help reduce tax bills, three first three topics are good places to start if you’re looking to take the sting out of next year’s tax bill.
If you have any questions or would like to learn more about reducing taxes, please contact a Financial Advisor at (916) 269-0671 or complete our contact form.