The basic strategy for paying less taxes and maximizing your tax refund is twofold: 1) decrease your income and 2) increase your deductions. Here are some ways you do both so you'll get a lower tax bill come April 15:
First, Estimate Next Year's Tax Burden
Use a tax estimator, like TurboTax's free TaxCaster, to see you how much you can expect to owe or get back from Uncle Sam next year. The exercise of finding and adding up all the line items will show you whether itemizing your deductions will pay off more than the standard tax deduction, and also help you spot areas where you can spend more to save more.
For example, miscellaneous itemized deductions such as unreimbursed employee expenses are limited to 2% of your adjusted gross income (AGI). (Tax estimators can help you figure out your AGI or your can refer to the previous year's AGI on your tax return, if your income and financial situation hasn't changed much.) Tallying those possible deductions up now and estimating your taxes will help you see if you're close to meeting that 2% minimum?in which case, buy all the stuff that would qualify as miscellaneous deductions now (professional membership dues, tools or supplies used for work, work clothes, etc.)?or nowhere near that minimum?in which case, hold those expenses until next year.
Decrease Your Income for This Year
Don't worry, you won't be making less money, you'll just be shifting your income to next year or using your income more wisely.
- Ask your employer to pay any bonuses next January instead of at the end of the year.
- If you're a freelancer, similarly, defer billing your clients for work until the start of the next year.
- If you're retired, postpone an IRA withdrawal, since that counts as taxable income.
- Thinking about selling a stock or other investment? If the investment had taxable gains, wait to sell it until next year.
- Increase your 401(k) or IRA contributions (deductible IRA, Simple IRA, or SEP). These tax-favored retirement vehicles lower your taxable income. You have until Dec. 31 for 401(k) contributions.
Increase Your Deductions for This Year
On the flip side, you'll want to spend towards all the things that decrease your taxes. If itemizing your deductions makes more sense than taking the standard deduction:
- Make a cash donation or take advantage of this opportunity to get rid of clothes clutter or other items and donate them (get receipts for $250 or more).
- Pay bills with deductible items early. For example, if you pay your January mortgage in December or first quarter property taxes now, you can deduct the interest and taxes on this year's tax bill.
- Sell some stocks. Have a stock or fund you've been meaning to sell that's plummeting and will generate a loss? Sell it now so you can deduct the loss. Note, however, that this strategy should be taken with a grain of salt?don't just sell a security for one year's tax savings. There are many things to think about when it comes to investing and maximizing your taxes; check out Smart Money's article on year-end tax planning for some other considerations.
- Buy more tax-deductible supplies or equipment. If you run your own business, e.g., as a freelancer, increase your deductions by buying more stuff this year (yay, office supply shopping and computer purchases!).
- Enroll in?and pay for?that higher education class now, so you can take IRS's learning credits ($2,500 for the American Opportunity Credit or $2,000 for the Lifetime Learning Credit).
Also check your unreimbursed medical expenses. If they're close to or more than 7.5% of your AGI, now's the time to have that major dental work, buy several pairs of eyeglasses, or stock up on meds.
Finally, if you have an Flexible Savings Account (FSA) , make sure you drain it by the end of the year.
The IRS has a couple of other year-end tax-saving tips, including getting a tax credit for adopting a child, but a rush adoption before Jan. 1 isn't as much of a smart financial move as buying more office supplies or increasing your IRA contribution.
What are you doing now to prepare for next year's tax bill (if anything)?
Photo by iQoncept / Shuttertock .
You can follow or contact Melanie Pinola, the author of this post, on Twitter or Google+.
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