This is a question we hear often. We understand that the world of tax can be overwhelming and confusing. How to reduce your tax bill is a complex question that relies on numerous factors and may not be the same for all wage earners.
Moreover, the question relies on whether or not you believe tax rates will be higher or lower in the future. It’s important to note, most “reductions” in your tax bill are actually deferrals to a future date and time when you have no idea what tax rates will be or how income will be taxed. You should really talk to an experienced professional about what this means to you.
With that said, there are options to reduce your current tax obligation through deferral mechanisms.
How Can I Reduce my Tax Bill as an Employee?
As an employee, you have limited options when it comes to reducing your tax bill. Here are a few effective options you may consider:
Traditionally a 401(k) is one of the best ways to reduce your current taxes as an employee. Remember, this tax obligation did not go away, you simply deferred it from the current year. However, most employees aren’t maximizing the amount the IRS allows them to put into their 401(k) each year on a pre-tax basis and may be losing out on additional deferral.
When looking at national trends, typically employees usually put in an amount equal to their company match. For example, if someone makes $100,000 a year and has a match of up to 5% of their annual compensation, most people are putting in close to that 5%. That’s only $5,000 per year of pre-tax contribution.
But the IRS allows you to put up to $22, 500 into your 401(k) on a pre-tax basis. That means one could defer an additional $17,500 above the $5,000 referenced above of income for tax purposes by contributing the max to their 401(k). If the individual is over 50 years old, you can contribute even more.
Health Savings Account
A Health Savings Account can reduce your tax bill.
You put money into your health savings account before it is taxed, and you can use it for healthcare-related expenses tax-free.
Flex Savings Account
A flex saving account works similarly to a Health Savings Account and can be used for medical, dental, and dependent care needs. It can help reduce your tax bill because your contributions are funded with pre-tax dollars.
How Can I Reduce my Tax Bill as a Business Owner?
As a business owner, the options to reduce your tax bill will increase dramatically. For example, you can do many of the same things an employee can do, but owning your own business or real estate gives you more control over your tax liability.
Cash Balance Plans
As a business owner, implementing a Cash Balance Plan is one example that can reduce your taxable income in the current year but defer to a later date. A Cash Balance Plan is a bolt-on strategy to certain 401(k) plans that allow those considered to be highly compensated to defer amounts greater than the 401(k) limits mentioned above. There is a requirement that some benefits must also be provided to those not highly compensated, but in many cases, the tax savings may offset the amount paid to those who are not highly compensated. You should talk to your Advisor to see if a Cash Balance Plan is a good addition to your existing benefits plan.
For example, you may need trucks or other equipment to run and operate your business. Under the current tax law, Section 179 says that if you’re buying a vehicle for business use, you can deduct a portion of its value from your tax bill.
The vehicle can be used solely for business use or only partially. You can use this benefit even as an independent business owner, especially if the vehicle is over 6000 lbs.
Many vendors will allow you to pre-pay your annual expenses and even give you a discount for doing so. The IRS has laws around this, but the most important one is the 12-month law, where you only get credit for 12 months.
Consider the Options that are Best for You.
At Prevail, we use a team-based approach to customize wealth-creating strategies for you, but you should always consult a tax professional when looking for tax advice.
So, if you are wondering, “How can I reduce my tax bill?” talk with one of our advisors about your options.