Tips for Tax Filing in the Future
Tax time is near, and soon everyone will be rushing to get their taxes filed. Last year, Americans were met with quite a few delays in getting their refunds with the onset of the pandemic.
If you have a refund coming, the sooner you file, the sooner that refund will make its way into your bank account.
If you’re like most tax filers, you probably want to do everything you can to reduce your overall tax bill. We know that taxes are needed to run the government, but there’s no need for you as an individual to pay more than you need to.
Here are a few areas to consider or understand for future tax filing years:
- Funding tax-preferenced accounts. One way to save on taxes is by putting money in various tax-preferenced savings accounts such as an IRA, a 401(k), and others. Depending on the account type, you can deduct your contribution each year, defer paying taxes on growth or take withdrawals tax-free. In health savings accounts (HSA), you can do all three. There are eligibility requirements you need to meet. An HSA can only be used for medical expenses. With a traditional IRA, you don’t pay taxes on your contributions, and you defer taxes on the account’s growth. You do pay taxes on withdrawals you make in retirement. A Roth IRA has different advantages. You can’t deduct your contributions now, but your money grows tax-free, and you aren’t taxed when you make withdrawals.
- Using a 529 for K-12 private or college education. Many people are familiar with 529 plans, but they often think of these solely to save for a college education fund. But a 529 can also be used to pay for a private school in elementary and high school. The significant tax advantage with a 529 is that you don’t pay federal income taxes on the account’s growth. However, you must spend the money on qualified educational expenses and nothing else. This is essential to remember and understand because if you use the money for other reasons, you will pay taxes on that withdrawal, and you will also pay the penalty. A 529 account is something to consider if you have children or grandchildren and want a tax-efficient way to save for K-12 or college education.
- Making charitable donations. Charitable donations are a great tool for reducing your tax bill. They come with the bonus of allowing you to make a positive impact in your community. Through charitable donations, you can reduce your income tax, capital gains tax, and estate tax. Some people view this most straightforwardly – you choose an organization that qualifies under the tax rules to donate to. There are other ways to contribute as well: You can establish a donor-advised fund, which is a personal charitable account opened in the name of the donors and held by a nonprofit organization. For example, let’s say you sell a stock and, instead of paying the capital gains tax, you choose to place the proceeds in a donor-advised fund. You can claim the total amount as a charitable deduction, although you don’t have to donate the money in one lump sum. The money remains in the fund and can be donated in small amounts over a period of years while drawing interest.
These are just a few things you can consider as you look for ways to reduce your tax bill. Your financial professional will be able to help you work your way through the process and find what works best for you and your situation.