When we meet with new clients and business owners, we often hear that their major priority is to find ways to pay less in taxes and save money for other initiatives including growing their business, retirement and charitable projects.
One of my early mentors once told me that if you want to pay less in taxes you need a plan, I never realized and appreciated how important this statement was until I started looking at our own finances and serving clients with their Accounting and Tax need. Over the years I realized that most of us, including myself at some point, take a reactive approach to tax savings. We often start worrying about taxes in January and like going to the dentist, we try to either delay the process or make it go away as quickly and as painlessly as possible.
Over the years of working with clients across the United States, we identified twelve key strategies to help you Pay Less in Taxes and Save Money. Let’s explore them all below…
Work with a Trusted Advisor
Early in my career, I realized that if we truly want to help clients Pay Less in Taxes and Save Money, we needed to take a much more Holistic Approach to Your Finances rather than just help to keep accurate accounting records and filing tax returns. Paying less in taxes is not about filing this year’s tax returns and making sure everything is recorded on the right forms, in order to really minimize your tax burden, you need to look to the future.
Filing tax returns is simply about recording what happened last year, identifying tax saving strategies is about planning and aligning your goals with potential ways to reduce your tax liability. This brings us to the first strategy, work with a Trusted Advisor that takes an interest in your goals and identifies tax-saving opportunities that are customized to your unique situation. A trusted advisor is someone that goes beyond just filing tax returns and providing generic tax-saving tips instead, he or she is developing a custom plan unique to you. Someone that owns a business might have vastly different tax-saving opportunities than a W-2 taxpayer. A true Trusted Advisor also works as a team with other professionals including attorneys, financial advisors and insurance agents to create a planning strategy that aligns with your long-term goals.
Working with a Trusted Advisor sounds good, but isn’t this going to be expensive? Most Trusted Advisors will be able to quantify the potential tax savings they are able to generate when working with them, these savings usually far exceed any fee you might pay for their services.
Keep good accounting records
Maintaining good financial records is critical in order to have a foundation that will assist both you and your Trusted Advisor make important financial and tax-saving decisions. Good accounting records are especially critical for business owners, without good business records you cannot properly manage your business, identify cash flow issues ahead of time and, implement proactive tax planning strategies throughout the year.
With good records, you can uncover a wealth of additional deduction you might not know even existed. For example, most taxpayers don’t know that you can deduct both Medical and Charitable miles, but without accurate records, you cannot take advantage of these deductions.
If you are a business owner, you should consider outsourcing your accounting to a professional that can assist in making sure your records are updated regularly. Do I really need to work with an Accountant to handle my bookkeeping? Absolutely yes! In this article, we discuss the cost of outsourcing accounting and the massive benefits it provides to business owners which far outweigh the fees to have your accounting maintain by a professional.
Own a Business
Owning a Business opens you up for major tax-saving opportunities compared to an individual W-2 taxpayer. Keep in mind however, that there is a major difference between running a business and having a hobby. The IRS can assess massive penalties and interest if you attempt to disguise a hobby as a business. In this article, the IRS offers tips to identify if your activity is considered a Hobby or a Business.
Maximize Business Deductions
If you are a business owner, you want to take advantage of all possible Small Business Tax Deductions available to you. In this article we discuss the top 21 small business tax deductions available in 2020, discuss these with your tax advisor to make sure you are taking advantage of every single potential deduction.
Update your W-4 and run Tax Projections
If you don’t own a business and have consistently been receiving large refund checks, you might want to consider adjusting your W-4 to make sure fewer taxes are deducted from each of your paychecks. While this will greatly reduce or even eliminate your refund when filing your returns, you will receive a larger net pay that can be used for other projects. You are receiving a large refund because you are overpaying in taxes, so why give the Federal Government a zero percent loan each year when you can use your money more efficiently?
The IRS provides a calculator and suggestions on how to adjust your W-4. If your tax situation is more complex including income from different revenue streams like Dividends, Interest, Rental Properties, you might want to engage with an accountant that can run more accurate tax projections.
Optimize your College Saving plan
The new tax law has significantly enhanced the benefits of funding a 529 plan for college savings. Every state has different rules related to 529 plans, some states allow you to deduct from the taxable state income the amount contributed to a 529 plan, other states do not offer this benefit. However, in all cases, the major advantage of a 529 plan is that funds in this account can grow tax-free if used for education purposes.
529 plans also provide a great deal of flexibility, giving you the option to transfer amounts between accounts if you decide that one child needs additional funds compared to the other. Total contributions to 529 plans are set by individual states, to avoid federal gift tax consequences taxpayers can contribute up to $ 15,000 in one year without any issues.
Maximize your 401(k) or other retirement plans
If you are an employee, you should consider maximizing your employer retirement options in order to take advantage of any employer match offered to you. By doing so, you are accumulating a nest egg using tax-deferred dollars.
As a business owner, there are several retirement options available that could be beneficial including SEP, SIMPLE and Solo 401(k) products. Each of them has benefits and drawbacks that must be considered therefore, it is important to discuss these options with your Trusted Advisor.
Keep in mind that 401(k) is a tax-deferred product, meaning that you are funding these accounts with pre-taxed dollars. Upon retirement, however, the distribution will be taxed at your current tax bracket. There is a consensus that tax rates could go up in the future therefore, you could be in a higher tax bracket when you retire. In that case, you should discuss with your Trusted Advisor if diversifying your investments in a mix of pre-tax and post-tax products might make better sense.
Select the right Business Entity
If you are a business owner, selecting the right business entity could result in massive tax savings. You might be asking yourself: Wait a minute! Do I have a choice? Yes, absolutely. Sole Proprietorship, S Corporation, C Corporation are all entity structures that provide different tax advantages and have drawbacks that need to be considered. You Trusted Advisor should review and provide projections intended at helping you select the best business entity type for your long-term goals while reducing your overall tax liability.
Plan Standard or Itemized deduction ahead of time
Often, clients think they have no ability to influence whether they elect the Standard or Itemized deduction. Especially with the new tax law and doubling of the Standard Deduction, most taxpayers no longer have enough expenses to itemize.
However, with proper planning, you might be able to save tax dollars by taking the standard one year and electing itemized deduction the following. Your tax professional can discuss a bunching tax strategy to see if you might be a good fit for your individual situation.
Fund your FSA or if Self Employed an HSA
Another area often overlooked is the funding of FSA or HSA accounts. If your employer offers an FSA account, you should consider taking advantage of this even if you are healthy. This allows you to fund an account used exclusively for medical expenses. The great thing about these accounts is that your employer could offer a dollar for dollar match.
Similarly, HSA accounts are a great alternative if you own a business, allowing you to invest tax-free dollars that can grow and be used without any tax impact for medical expenses. You cannot contribute to an HSA account once you are receiving Medicare, therefore this is a great long-term strategy to invest tax-free dollars in a special account that can be used post-retirement to help pay for medical expenses.
Purchase a House
Purchasing your own house is still a great strategy to reduce your overall taxes. While the benefits of owning might appear to have been reduced by the new tax law since there is a cap in the deduction for Property Taxes and Mortgage Interest, there are still massive advantages of excluding capital gains when selling your home.
Selling a primary home that has been appreciated in value can often result in substantial capital gains. In general, you can exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse. Special rules do apply, so make sure you discuss this with your tax advisor.
Purchase Real Estate Investment Property
Purchasing Real Estate Investment can be a very effective tax reduction strategy. Because of depreciation, a large portion of Rental Income is greatly reduced, in fact, it is not uncommon for us to see Rental Properties that are cash flowing positively but are carrying a paper loss.
Many advanced tax planning strategies can be structured around Rental Real Estate Investment Properties therefore, these can be a very effective vehicle for long term wealth creation with very little to no tax impact. As always, consider consulting with your Trusted Advisor to discuss and implement tax reduction strategies that are unique to your individual situation.