Editor’s Note: Please welcome XYPN member advisor PJ Wallin (CFP®, CPA) to the blog today! PJ was generous enough to provide us with a post containing a wealth of information to help you enjoy tax savings this year and next. We'll let the expert take it from here!
It’s that time of year where folks pull out their W-2s, 1099s, and other tax documents, open up TurboTax, or send their info on to their CPA. Often, we do so without even thinking about what we’re really doing by processing all these forms.
So this year, be different. Take 10 minutes to assess your situation before and after you prepare your returns. Doing so may help you save on your tax bill this year and in the future.
Where to Start Looking for Tax Savings
The US tax code is one of the largest honor code systems in the world. While the IRS has many checks and balances in place, please don’t expect anyone to let you know you’ve reported something incorrectly or missed it altogether.
They certainly will do so if it’s in their favor, but don’t count on them telling you about that missed tax credit or deduction.
Instead, play by the rules, report everything, and take advantage of the rules that may be in your favor (and vote accordingly in the next election for those you don’t agree with).
Start with Form 1040. All working Americans likely recognize this one. It’s the two-page form that summarizes our financial year.
Yes, there are hundreds of adjoining forms, but a brief understanding of page 1 of the 1040 can go a long way towards tax savings.
So without further adieu, below are some quick hits or low hanging fruit when it comes to tax savings on your personal federal tax return:
Line 7: Wages, Salaries, Tips, Etc (Form W-2)
A W-2 form reports your wage income (after pre-tax payroll deductions like health insurance and retirement savings).
All too often I hear people say, “My spouse and I are both wage earners, so there’s not much we can do to save on taxes.”
Au contraire my friends. Here are some quick hits that may provide tax savings -- and savings on stress -- each year:
Adjust Your Withholding: If you find yourself owing every year and you’re household is primarily filled with W-2 wage earners, adjust your withholding by filling out a new form W-4 from your payroll department.
While this isn’t saving anyone taxes, it assists in lowering or eliminating that tax bill and heartburn each April by withholding a little bit more tax each paycheck.
If you’re getting a large refund each year, do the same and pay yourself more throughout the year rather than waiting for the refund and letting Uncle Sam hold your cash.
Participate in Your Employer’s Retirement Plan:
- Roth 401ks may be the most powerful tax savings vehicle around. While you won’t get a tax deduction on the way in, under current law this account will never be taxed again. How’s that for savings!
- If you work for an employer stuck in the '90s, tell them to add a Roth 401k option, or participate in the regular 401k as it still has its benefits. You receive a tax deduction now, but the amounts and growth are taxed on the way out in retirement. Typically you’re in a lower bracket in retirement, so tax deferral is often better than nothing.
- I often tell clients to go Roth until they are above the 25% federal tax bracket, then switch to the pre-tax regular 401k. Think of it as tax diversification.
Assess Your Healthcare Options: If your employer offers a high-deductible health care plan combined with a health savings account (HSA), this may be another great tax savings/deferral strategy.
For each dollar contributed to an HSA you don’t pay income or payroll taxes as long as it’s used for a qualified medical expense. A flexible spending account (FSA) is similar but the dollars must be used annually.
Ask your HR department about these pre-tax employee benefits: If you’re already spending in these areas, you might as well be participating in the pre-tax benefit.
- Transportation and parking benefits.
- Dependent care accounts.
- Additional deferred compensation accounts (think accounts like 403b, 457, etc).
As you can see, while there may not be ways to impact the W-2 after the close of the year, there are many ways you can decrease your taxable income throughout the year.
Line 12 and Line 17
If you’re not receiving wage income, it’s likely you’re receiving income as a business owner or contractor. Many of the above tax savings options take a different form.
Schedules C and E are a topic for another day, but remember these simple steps:
- Track all your cash flow and provide it in an organized format to your CPA. (I’ve yet to meet a CPA who says too much information is a bad thing... unless you bring it in a shoe box.)
- Track your business mileage, at 56 cents a mile. It can add up!
- Retirement contribution options vary, but are still likely deductible.
- Health insurance costs are deductible.
Lines 23-36: Adjustments To Income
Everyone should take a quick look at this section of the 1040 each year before they finalize their returns. You never know what benefits may result.
Here's what to look for, line by line:
- Line 23: Are you an educator? Did you spend your own money on supplies for your classroom? Take an educator expense deduction of up to $250.
- Line 25: Did you have a high deductible health plan, but forget to contribute to the health savings account (HSA) during the year? Don’t worry, you can make the contribution up until the filing date of your return and claim the deduction here. Just make sure not to double count any contributions you already made through payroll.
- Line 26: Did you move a long-distance for a job? Those moving expenses are likely deductible.
- Lines 27, 28, and 29: These relate to self-employed individuals (those likely reporting their income on lines 12 and 17 above). Retirement plan contributions and health insurance expenses are tremendously powerful deductions for the self-employed. Don’t miss out!
- Line 32: Does your employer not offer a retirement plan option? This is your line. Contribute to an IRA and you can often receive an additional tax deduction.
- Line 33: Likely the most used important line item for many of Gen X and Y. Barring certain high income levels, here is where you deduct your student loan interest.
- Line 34: If you are working your way through school or taking additional classes while working, you may be eligible for a deduction for a portion of your tuition and fees. Be careful though; often it’s more beneficial to take the education tax credits instead.
While many of us dread tax time each year, do yourself a favor and take a quick glance at page one of the 1040 before preparing your returns. Who knows -- you might save a few bucks now or in the years to come!
Disclosure: Please consult with your attorney, accountant, and/or tax advisor for advice concerning your particular circumstances.
About the Author: PJ Wallin, Founder of Atlas Financial, is a CPA and CFP®. He combines his accounting roots and his financial planning & investing acumen to provide the all-in-one Atlas Experience: eliminating multiple agents — a CPA, insurance advisor, investment advisor, financial planner, etc. — to make managing finances easier, clearer and more effective.