Now that tax season is finally over, it’s time to start thinking about next year. It’s the financial moves we make (or don’t make) throughout the year that set us up for success or failure in the following tax season.
As the full-fledged effect of the new tax code begins to take shape, many people are surprised to find that, instead of refunds, they owe taxes to the IRS. Changes in the new tax law are leading to confusion as people are trying to figure out the new tax brackets and standard deductions.
Keep on reading to find out what has changed, who is the most affected by the new tax code and nine ways to reduce your tax bill next year.
What changed relative to the previous year
The new tax law passed in December of 2017 changed many pieces of the previous tax code. Financial experts and analysts find it difficult to pinpoint the exact reason why the changes are affecting people differently.
A significant impact comes from alterations to withholding tables.
Other alterations to the tax code include an increase in the deduction for single filers at $12,000 and married couples filing for $24,000 and a higher tax credit for children which doubled from $1,000 to $2,000 per child as of last year. The new law also eliminated personal exemptions.
Who are the most affected by the recent changes?
The group that will suffer the most significant impact are those who didn’t alter the number of deductions from their paychecks in their W-4 forms.
Furthermore, as people gear up for tax season, about half the taxpaying population doesn’t understand the impact of the new law on their tax bracket and almost 30 percent are clueless as to what changed with the introduction of the new law.
The most at risk are also individuals who itemize their deductions, homeowners in high tax counties, employees who have unreimbursed business-related expenses, and taxpayers with no dependents.
9 things you can do now to reduce your tax bill next year
1. Contribute as much as you can to a 401(k), 457 or 403(b) plan
There’s a general rule regarding taxes that says the more income you have, the higher your taxes will be. So to get around this, you can actually have less income and lower your taxes, but it doesn’t mean you earn less to qualify for a lower tax rate.
Adjusted Gross Income (AGI) is the benchmark for calculating your tax. The greater your AGI is, the higher the tax gets. The critical takeaway from AGI is the word adjusted. The key to reducing your taxes lies within this. If you make higher contributions to your 401(k) or any other retirement plan, your pre-tax (AGI) income will be lowered.
There are two main advantages of doing this:
- your taxes are lowered as you reduce your taxable income
- you don’t end up paying taxes on the investments returns until you retire
2. Make student loan payments
Students are encouraged to pay for college without taking a loan if they can, but if the situation forces their hand to opt for a student loan, then there is still a silver lining, as the interest you pay on a student loan is beneficial towards lowering taxes.
Almost 70 percent of the graduates from across US colleges have student loan debt. You can deduct up to nearly $2,500 of interest per year paid on your student loan debt from taxes. However, if you’re earning more than $80,000 a year, you cannot claim any deductions. Similarly, if your taxable income is between $48,000 and $65,000, your deduction gradually phases out.
So assuming that you’re in the 25 percent tax bracket, a full claim of the $2,500 on interest deductions could cut your tax bill by $625.
3. Purchase a house
If you’re thinking of purchasing a home, it might end up as tax savings, as property taxes and mortgage costs (interest payments) are deductible.
The new tax law has introduced changes to whether you’re eligible for a break for purchasing a house. For the tax years of 2018 to 2025, you can deduct interest payments on mortgage debts up to $750,000.
Similarly, property buyers can deduct up to $10,000 of state and county taxes including state income tax and property taxes.
But to take advantage of these limits, you will have to itemize your deductions on Schedule A. You can opt for either itemized deductions or standard deductions, whichever one gives the highest tax break.
4. Using external help to file for returns
If you have a simple tax situation, you can opt to file on your own or by using a tax preparation software. We recommend the following tax software:
- TurboTax – the most advanced tax software, also the most expensive
- Liberty Tax – one of the best if you’re looking for in-person and online tax filing
- H&R Block – best for those who want the most advanced hybrid in-person/online software
- TaxAct – This is the cheapest tax software, so best for those with simple returns
- E-file – If you think you’re susceptible to an audit, E-file is best.
But if you have a complicated tax situation owing from multiple income streams or investments, you could opt to use an expert who can identify opportunities that were unknown to you.
Some tax experts even offer a money back guarantee, whereby you’re reimbursed by the tax preparer in case you dished out more than you should have.
A qualified tax preparer might be a better choice in these situations as they are required to be up-to-date with any changes made in the tax law. A non-credentialed tax preparer might charge a lower amount but might not be up to date with the latest changes. You can use the IRS database to seek our qualified and credentialed tax preparers.
5. Carefully choose your filing status
Your filing status plays a vital role in your taxes as it ultimately determines your standard deductions and the applicable tax rate.
For instance, for the tax year 2018, the deduction for a single filer stood at $12,000, but a taxpayer who claimed to be the head of a household had a standard deduction set at $18,000.
Depending on your situation you may choose between two distinct or a single option from the following filing statuses:
- Single. This filing status applies to all those taxpayers who are not yet married or living separately under the law (even divorced).
- Married Filing jointly. Individuals who are married can file for a joint return with their partners, and in case of the demise of a partner during the tax year, an individual can still file for a joint return for the relevant year.
- Separate filing for a married couple. A married couple can opt to file separately, but this hardly results in a lower tax bill.
- Head of a household. This status applies to unmarried individuals supporting a dependent such as a child or parent.
- Qualifying widow with underage children. This status applies to taxpayers whose partner passed away during the current tax or the previous two years and has a dependent child.
6. Take advantage of tax loss harvesting
If you have loser investments in your portfolio that don’t have a bright future, you can sell them and offset the losses against capital gains and income tax. Tax loss harvesting can deduct taxable income by as much as $3,000.
And the best part is, the strategy can be carried forward indefinitely. Meaning if you sell your losing investments in the current year, you can utilize tax loss harvesting in subsequent years if you realize any capital gains. Or it can even be used to offset your regular taxable income.
The strategy is extremely beneficial if your cash flows are going to be higher than usual and you want to avoid paying a higher tax.
If you use a robo-advisor, tax loss harvesting is typically included automatically for you.
7. Store your donation receipts
There’s a silver lining beyond feeling good about donating to charities. You can claim tax deductions against your donations to charities that are listed by the IRS, so it’s imperative you save the receipt when dishing out donations to be applicable for a tax break.
The documents required for being eligible for a tax break are as follows.
- Cash donations of under $250. A bank record (such as a statement or canceled check will do) containing the name of the charity and the amount of the donation along with the date.
- Cash donations for $250 or higher. In this case, the IRS requires a written acknowledgment from the charity which must contain the name of the organization, the amount donated and a written acknowledgment that the donator didn’t receive any goods or services against the contribution from the organization.
Save all receipts for these donations including any property or vehicle donations.
8. Pursue further education
Your tax bill could potentially be lowered if you opt to pursue a college degree. There are education-related expenditures that are eligible for a tax break.
The American Opportunity Tax Credit and the Lifetime Learning Credit are such examples. The American Opportunity Tax Credit is available only for the initial four years of undergraduate degrees, and the qualifying criteria are that you must be enrolled at least half-time in a degree awarding program. The program offers $2,500 in a tax break, and if you still have an amount owing after your taxes are zero, you can refund 40 percent ($1,000) as a refund.
The Lifetime Learning Credit is more general and broader, and there’s no limit on the number of years you can lay claim, and you don’t have to be listed in a degree awarding program.
9. Energy efficient improvements to home
You qualify for a tax break by opting to make your home more energy efficient. There’s a ton of renewable energy tax credits available for homeowners that you can apply for in the current 2019 tax year.
These tax breaks are applicable if you install solar power or solar powered water heaters at your house. Other products that qualify for a tax break include wind turbines, geothermal heat pumps, and even renewable fuel cells.
The break is almost equal to 30 percent of the cost of the home improvement project that leads to greater efficiency. The claim applies to both primary and secondary residences.
These are just a few of the things you can do to reduce your tax bill for next year. If you want to find more hacks, you may want to consult a tax advisor.
For now, focus on lowering your adjusted gross income by maxing out the retirement accounts you can. After that, utilize these other tips for making next year the most tax-friendly year ever.