3 Ways to Reduce Taxes
Today taxes are due in the U.S. If you live in LA County, you get an automatic extension to October 15th. And yes, this is for both Federal as well as California State taxes, due to the federally declared wildfire and wind disaster in January.
Each year on April 15th, I am reminded of my father sitting at our dining room table, doing his taxes until the midnight deadline.
Every single year, he waited until the very last minute.
Every single year, he was visibly stressed.
If you went to ask him a question, you would get your head bitten off!
If you were quietly moving behind him, you would also get your head bitten off!
It felt like the biggest burden and that we were all to blame for his procrastination.
It’s a memory that has shaped how I see money and how I deal with money.
For one, I don’t recall a year I waited until April 15th to do my taxes.
I usually started them as soon as I was able to gather all of my necessary forms, and yes, I did file my own taxes, prior to being married.
Beyond the practical, the memory of my father at that dining room table hit me on a deeper, more emotional level.
I’ve said it before in this blog and elsewhere, but children don’t understand money. Children don’t understand taxes. Heck, most adults don’t even understand taxes.
So, what I learned as a kid, tiptoeing around my father as he did his taxes, was that money and taxes caused stress, and it made people angry and feel burdensome.
I did not want that kind of stress, and I also didn’t want to be angry or to feel those burdens, so in my late teens and all the way into my 20s, I unconsciously made money a “non-entity.”
I just didn’t think about it at all.
I worked and brought in money, but as soon as it came in, it went out.
The summer between my Senior Year of High School and NYU, I had a really “cool” job at a music and video store. It paid practically nothing.
Minimum wage, at that time, was $4.25 an hour, and that’s what I made. I don’t think any of us even worked full time. There were so many “kids” who worked there, and we probably made about $80 a week or $320 a month.
At that time, my parents had moved us to Seattle (yes, I had to move my Senior year of high school), and it was in the early 90s, during the peak of the grunge era. So, every single weekend, my co-workers and I would buy concert and festival tickets with the money we made.
That summer, I saw Henry Rollins, Pearl Jam, Red Hot Chili Peppers, L7, Beastie Boys, Sonic Youth, Mudhoney and so many more bands at Lollapalooza, EndFest, and other festivals.
I almost got crushed in the mosh pit during the L7 set, but I digress.
As you can see, I definitely wasn’t saving any of my money.
Instead, everything I made went to concert tickets, gas for my lime green Geo Metro, ferry tickets to get to Bremerton Island to attend the festivals, or for going out to eat, late at night, after a concert.
What does any of this have to do with taxes?
Well, if you’re a parent, it’s about how you feel around money and taxes, then it is about trying to teach your children about the practical lessons on saving and investing.
If you’re not a parent, start to examine your own beliefs around money that you “inherited” from your parents, grandparents, or sometimes what your friends or classmates say and do.
And if you do have an extension on your taxes, here are 3 practical ways to reduce the amount you need to pay (from Fidelity):
1. Reduce taxable income
Lowering the amount of your income subject to taxes is one of the most effective ways to reduce your tax bill. Duh. But how do you do that?
Consider maxing out tax-advantaged accounts. Contribution limits on workplace plans such as 401(k)s and 403(b)s are generally bumped up each year. In addition, anyone who has a high-deductible health plan should check if they are eligible to contribute to a health savings account (HSA). Since HSAs are triple tax-advantaged—contributions aren't subject to federal income tax, invested contributions have the potential to grow tax-free, and withdrawals are tax-free when used for qualified expenses—you may want to consider covering your current health care expenses with cash and using the HSA as another way to increase retirement savings.
Manage your bracket. Tax-bracket creep—when you’re pushed into a higher bracket—can result from the sale of a house, a bonus, severance package, or many other one-time income bumps. Higher-income taxpayers may also find themselves subject to the net investment income tax (NIIT), a 3.8% surtax on capital gains, dividends, interest income, and other forms of investment income. If you're close to the top of a bracket, you may want to see if it makes sense to defer some income (perhaps from self-employment or the sale of stocks) to the following calendar year.
Alternatively, if your taxable income is unusually low in a certain year, it could be a good time to consider converting a traditional IRA to a Roth IRA.
Be mindful of retirement account withdrawals. At age 73, the IRS requires you to take minimum withdrawals from traditional IRAs, and 401(k) accounts if you are no longer working for the company. Those withdrawals are generally taxed at your ordinary income rate. Depending on the types of accounts you own and your account balances, among other factors, it may or may not make sense to draw down these accounts sooner or at a faster rate. If you are charitably inclined and have the means, you may want to consider donating funds from your IRA with a qualified charitable distribution.
2. Maximize potential deductions
The 2017 Tax Cuts and Jobs Act roughly doubled the standard deduction, making itemizing deductions more difficult. By planning ahead of time, however, itemizing deductions can still be a powerful way to lower your tax bill.
Bunch charitable contributions. If you don't normally itemize, "bunching" several years' worth of donations into a single year may push you over the threshold for itemizing one year, allowing for larger tax savings than spreading out the donations across several years. This strategy may also be effective in potentially mitigating tax consequences from a higher-income year where you might bump into a higher bracket. One option that may help with both tax and legacy planning is a donor-advised fund (DAF), which allows you to take an immediate tax deduction, and then recommend grants to various charities over time.
Keep tabs on medical expenses. You can deduct medical expenses that exceed 7.5% of your adjusted gross income. If you might be on the threshold in a given year, consider accelerating any qualified expenses and paying medical bills before year-end. Qualified expenses include everything from out-of-pocket hospital fees to prescription drugs, insurance premiums, and much more.
3. Layer on tax-smart investing strategies
Taxes generally shouldn't be the driver of investing decisions, but once you have an asset mix that makes sense for your time horizon and risk tolerance, adding tax-smart techniques can help you keep more of your return—adding as much as 2% per year on average, according to one study. Fidelity has found that the average client with a Fidelity Personalized Portfolios account using tax-smart strategies could have saved $4,137 per year in taxes.
Know the rules around capital gains. If you're selling assets to rebalance or raise cash, keep in mind that securities held for 12 months or less are generally taxed as short-term gains, at a rate as high as 40.8% (37%, plus 3.8% net investment income tax, or NIIT). State and local taxes may also apply. The federal rate on those held for more than 12 months, on the other hand, tops out at 20%, plus the 3.8% NIIT.
Harvest losses. If you have realized a net capital loss in a tax year, you can use up to $3,000 of losses to offset ordinary income ($1,500 if married filing separately). You can carry forward any remaining unused losses to future years. When markets fluctuate, this can increase the number of opportunities to benefit from this technique.
Consider tax-efficient investments. Different investments tend to generate different levels of tax impact. In general, passive (index) funds or ETFs tend to be more tax efficient than actively managed funds, as do mutual funds that explicitly call out tax efficiency as an objective. While many bonds and bond funds generate income that is taxed at the investor's ordinary rate, municipal bonds and muni bond funds are typically exempt from federal taxes. State-specific municipal bonds and muni bond funds may also be exempt from state taxes.
Look at location. A diversified portfolio can't be limited to tax-efficient investments. An asset location strategy seeks to, when possible, match assets that are less tax-efficient to tax-advantaged accounts, and vice versa.
Be mindful of mutual fund distributions. Mutual funds generally distribute earnings from interest, dividends, and capital gains every year. This can even cause you to pay taxes in down-market years. Regardless of how long you have held a fund, you're likely to incur a tax liability if you own it on the date of that distribution, so you may want to consider taking that date into account when making buying or selling decisions.
Also, families who are interested in passing on wealth should keep in mind that the lifetime estate and gift tax provisions are scheduled to sunset, or expire, at the end of 2025. Here are more details:
To learn more about the tax filing extension for LA County residents, please visit:
https://www.irs.gov/newsroom/irs-announces-tax-relief-for-taxpayers-impacted-by-wildfires-in-california-various-deadlines-postponed-to-oct-15
With Love & Gratitude,
