Taxes are our biggest ongoing expense, so it’s smart to manage them wisely. This article will share effective ways to reduce your tax bill by the end of the year, updated annually to reflect new tax laws.
After quitting my job in banking in 2012, I shifted from aiming for maximum income to protecting as much of my earnings from taxes as possible. It felt unnecessary to earn more than $200,000 per year, even in pricey San Francisco, as higher earnings didn’t equate to increased happiness but did lead to higher taxes and more stress.
Now, supporting a family of four, I aim for a household income of up to $400,000. This amount strikes a balance between earning enough to enjoy life and not losing too much to taxes. I believe an effective tax rate of 25%–30% feels fair—it’s enough to contribute meaningfully to society without feeling overburdened.
Strategic Year-End Tax Moves:
1. Boost Charitable Giving: If you itemize deductions, remember to donate cash and goods to qualified charities and keep detailed records. For substantial non-cash donations like cars or stocks, specific rules apply to maximize deductions. Remember, your generosity not only helps others but can also reduce your taxable income significantly.
2. Harvest Tax Losses: If investments have lost value, consider selling them to offset gains. You can use losses to balance out gains dollar-for-dollar, with up to $3,000 of excess losses carrying over each year.
3. Prepay Expenses: If you anticipate a high-income year, accelerate deductible expenses. This can include paying next year’s expenses in advance, such as state taxes or property taxes, provided you don’t hit the SALT deduction cap.
4. Max Out Retirement Contributions: Fully fund your 401(k), IRA, or other retirement accounts to reduce your taxable income. If you’re self-employed, setting up a solo 401(k) allows significant pre-tax contributions.
5. Consider a Roth Conversion: If your income is lower this year, converting a traditional IRA to a Roth IRA could be advantageous. You’ll pay taxes at a lower rate now and enjoy tax-free growth going forward.
6. Optimize Business Deductions: If you run a business, delay invoicing or accelerate expenses to manage taxable income. Purchasing necessary equipment or prepaying for next year’s expenses can also lower your tax burden.
7. Manage Education Expenses: Contribute to a 529 plan for college savings to benefit from state tax deductions and tax-free growth, maximizing the impact of your contributions.
8. Adjust Withholdings: If you haven’t withheld enough taxes, update your W-4 form to avoid penalties. This is especially crucial for those with irregular income streams.
By implementing these strategies, you can potentially save a significant amount on taxes, turning what you save into future investments or spending for personal enjoyment. Always consider consulting with a tax professional to tailor these strategies to your specific financial situation.
