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During the final weeks of the year, you may think about how to set up your finances so you have the best shot of getting a tax refund, if you’re owed one.
The good news is you can still make financial moves that will help you at tax time. When trying to maximize your federal income tax refund, a great place to start is to look at your taxable income and work on reducing that before the end of the year.
Less taxable income = less tax to pay
Your taxable income is basically what you get paid after deductions and exemptions are taken out of your gross income. You can find a list of examples of taxable income here.
Reduce your taxable income, and you can reduce the amount of taxes you owe for the year. The IRS taxes you based on your taxable income. There are seven tax brackets for federal income tax, and how they work can be confusing.
Here are two examples to help you understand how a small difference in taxable income can create a big difference in how much tax you pay. Please note, these are rough estimations that don’t take into account any potential deductions or exemptions that would also reduce taxable income.
Imagine a couple that files their taxes jointly and has a total taxable income of $75,000. Technically, they fall into the 12% tax bracket. However, they don’t pay 12% on the total amount. Instead, they will pay 10%, the tax bracket below theirs, on the first $19,050 of their income. They will only pay 15% on the taxable income in excess of that first tax bracket threshold.
This is an example of the marginal tax rate in action.
Now imagine a second married couple, also filing jointly, that has a total taxable income of $85,000 — just $10,000 more than the first couple. Like our first couple, the second couple will pay 10% percent on the first $19,050 of their taxable income. Then they’ll pay 12% percent on the next $58,349 of their income. After that, there’s only $7,601 left over in the 22% category ($19,050 + $58,349 + $7,601 = $85,000).
So while the second couple only makes $10,000 more per year than the first, their income is subject to a higher marginal tax rate than the first couple, and unless they’re able to reduce their tax obligation with tax deductions or tax credits, they’ll likely pay more in tax.
However, if our second couple take steps to reduce their taxable income, they could find themselves in the same tax bracket as Couple A, and paying the same marginal tax rate.Learn how tax brackets work
Here are three simple ways to decrease your taxable income.
1. Put more into your retirement account
Putting money away for retirement not only builds your nest egg, it can also help reduce your taxable income now. If you haven’t already maxed out your retirement account contributions, consider doing so before the end of the year.
Retirement funds like 401 (k) and traditional IRA accounts are tax-deferred, which means you’ll pay the tax when you withdraw from those accounts later. That means you don’t pay taxes on them now, and they don’t go toward your taxable income. Don’t forget that this doesn’t apply to Roth IRAs or Roth 401(k)s. All the money contributed to those accounts is post-tax, which means that contributions cannot lower your taxable income.
For the 2018 tax year, the IRS lets you contribute:
- Up to $18,500 (or $24,500 if you’re 50 or older) to a traditional 401(k) account annually
- Up to $5,500 (or $6,500 if you’re 50 or older) to a traditional IRA each year
Whenever possible, it’s a wise financial decision to maximize your retirement contributions annually — it helps your retirement accounts and will help you save at tax time. Dec. 31 is the deadline for making 401(k) contributions for the tax year, unless the 31st falls on a holiday or weekend.
Also, keep in mind that if you make contributions via paychecks, it may take a couple of cycles to kick in, so you want to make those contributions as soon as possible. Fortunately, you have until Tax Day to make contributions to both traditional and Roth IRAs.
2. Contribute to a health savings account
If you have a high-deductible health plan (your deductible must be at least $1,350 for an individual plan or at least $2,700 for a family plan), you could be eligible to participate in a health savings account, or HSA. Or you could contribute to a flexible spending account, or FSA, regardless of the type of employer-sponsored health plan you have. Both FSAs and HSAs can help you save on health costs while decreasing your taxable income.
High-deductible health plans, or HDHPs, have higher out-of-pocket costs than other types of health plans, but lower premiums. In other words, your monthly premiums are low, but you’ll pay more for using healthcare services until you hit your deductible. Once you reach your deductible amount, the insurance company will start paying for health services as well.
HSAs are connected with HDHPs to help you pay for those higher out-of-pocket costs. You’re able to contribute up to $3,450 into an individual HSA and $6,900 in a family HSA.
The IRS doesn’t consider money contributed toward HSAs taxable income, and it doesn’t tax you when you withdraw the money to pay medical bills. Because your HSA (and FSA) contributions are made with pre-tax dollars, they can lower your taxable income.
You can itemize your HSA and FSA deductions on lines 1 to 4 on Schedule A (itemized deductions). Schedule A is one of the forms Credit Karma Tax® can help you complete if you use the free online tax preparation software to file your federal income tax return.
FSAs work in the same way that HSAs do, except they can be associated with any health plan. One key difference from an HSA is that FSAs belong to the employer , so you could lose the money if you leave your job, and FSA money typically disappears after the calendar year ends. HSAs, on the other hand, belong to the employee, so you take the account with you when you leave a job and the money carries over to the next year.
If you haven’t maximized your health savings contributions, it’s a smart move to do that before the end of the year. However, you do typically have until Tax Day to make HSA contributions. Keep in mind that if you have an FSA, you will need to use all that money by Dec. 31.
3. Give to charities
Donating to qualified charities doesn’t just assist worthy causes, it can also help you because you can deduct donations on your taxes.
The one catch is that the charity must be considered a qualified charitable organization. You can search online at IRS Exempt Organizations Select Check for qualified organizations or call 1-877-829-5500. Keep in mind, the IRS says you can never deduct a contribution made to an individual.
In order to claim this deduction, you’ll need to itemize your charitable donations on Schedule A of your 1040 tax form. That information is inputted on lines 16 through 19.
You’ll want to have proof of your donation, which can be a bank record, a credit card receipt or a receipt from the charity. To count for the tax year, you must make your contributions by Dec. 31.
If you come to the end of the year and find that you still want to reduce your taxable income, you can open your wallet and help your favorite charities.
No one wants to pay more than their fair share in taxes, and wouldn’t a big refund be great next year? By taking steps to reduce your 2017 taxable income in the final weeks of the year, you can help maximize your chances of getting a bigger refund in 2018.