Now that you have gathered all the related data to complete your taxes and found the right CPA to help as discussed in “How to Reduce Your Taxes Part I - Finding a Great Accountant,” let’s explore ways to reduce your taxable income and increase your deductions.
Do you know how the IRS calculates personal income taxes?
Our personal tax system is based on calculating Adjusted Gross Income, or “AGI.”
So, if you lower your AGI, you lower the amount you are taxed as a percentage of your income.
For example, if you receive Social Security, reducing your AGI reduces the tax on your benefits at certain income thresholds. The AGI sets the amount of deductions you can take.
If you can lower your AGI from say $131,451 to $65,101, assuming you are married, filing jointly, your tax goes down from $25,225 to $8,927. Your overall tax as a percent of your income drops from nearly 20 percent down to around 14 percent.
Your AGI determines if an IRA is tax deductible. Your AGI determines what medical expenses are deductible. Your AGI determines what business and professional expenses can be deducted. Your AGI even determines what losses can be deducted or at what rate capital gains are taxed. If your AGI is too high, your Social Security is taxed.
You get the idea – reduce your AGI and you can reduce your tax percentage.
So how do you lower your AGI?
You can find tips for reducing your taxes here. Here are just a few possible reduction strategies:
1). State Taxes – Move or consider having multiple residences. If you minimize your federal tax, chances are it will also minimize your state tax. If you have multiple homes, living longer in the state with lower state tax, in say, Florida versus New York, may save you a bundle.
2). Property – Challenge your bill by monitoring comparable properties and what their taxes are by having a real estate agent check them for you. All are public records.
3). Estate – The current estate tax rate is 45 percent. Prepare the right estate plan for your net worth. Having the right estate documents, asset titling and structure can save you a bundle upon death.
4). Hire Family Members – If you have children as bona fide employees and they are under the age of 18 working for a parent-owned unincorporated business, you are exempt from paying their SE/FICA taxes. That’s a savings of 15 percent! Perhaps, instead, you have a corporation. Does your spouse help out now and then with your business? Do you have your spouse on the payroll? By adding them to the payroll, you may be able to add them to the company’s retirement plan (SEP, SIMPLE, 401(k), etc) and dramatically increase the contributions as well as utilizing a company health savings account (HSA) and potentially lowering insurance costs.
5). Charitable Contributions – If you regularly give to certain charities, consider making it a business expense instead by asking the charity about advertising or hosting a client appreciation event through their special events.
For example, we did this in the summer of 2009 for a great cause, Children’s Cancer Research Fund, when they had their annual polo match. They fund the initial stages of cancer research that leads to large national grants to help make important vaccines and breakthroughs in cancer medicine. They also help families with children going through cancer, sort of like Ronald McDonald House.
As a cause we support and would give money to anyhow, we bought a tent for the polo event which in turn became a large donation to them. Additionally, we made a good use of marketing dollars by inviting clients to come to the match at our tent and everyone had a good time.
In Part III of “How to Reduce Your Taxes,” we will discuss how having a small business can lower your AGI and what types of business related write-offs you can utilize. Stay tuned!
Material discussed is meant to provide general information and it is not to be construed as specific investment, tax, or legal advice. Individual needs vary & require consideration of your unique objectives & financial situation. Please consult with your accountant or tax advisor for specific guidance.