The more of your money that you lose to taxes, the less you can put toward investing and becoming wealthy.
Consider that if you paid $5,000 less in taxes every year, and invested that money in the S&P 500 for an average return of around 10%, after 30 years of compounding you would have $904,717.12. Just from tax savings. (Use our Choosing Wealth Calculator to run your own compounding calculations.)
That could be enough to retire on!
Take control of your taxes so you can pay less, invest more, and accelerate your path to financial independence. Here are seven “sneaky” tax tips to help you slim your tax bill, and reach the finish line faster.
1. You Can Still Max Out Last Year’s IRA Contributions
One quirk in the US tax code is that for any given tax year, you actually have 15 ½ months to contribute to your IRA, Roth IRA, or SEP IRA.
That’s right: even though the calendar year is over, you can still contribute money to your IRA and have it count toward last year’s contributions. You have until April 15 – the tax return filing deadline – to make contributions for last year. When you make the contribution through your online broker, you simply select which tax year you want it applied toward.
It’s worth mentioning that this rule only applies to IRAs, and not 401(k)s.
For the 2018 tax year, taxpayers under 50 can contribute up to $5,500, while taxpayers over 50 can contribute an extra $1,000 as a “catch-up” contribution. If you haven’t maxed out your contributions yet, you can still do so to slash your tax bill and keep more of your money.
2. Consider a SEP IRA – Even If You Just Have a Side Hustle
Self-employed Americans have access to a unique form of IRA: the “Simplified Employee Pension” or SEP IRA. And it comes with a giant advantage over traditional IRAs.
The contribution limit for SEP IRAs is the lesser of 25% of self-employed earnings or $55,000 for tax year 2018. That’s ten times higher than the normal IRA contribution limit!
Even if you have a full-time job with good ol’ W-2 paycheck, you can still open a SEP IRA if you have a side hustle. Just remember that it may not be worth it if your side hustle doesn’t earn you much money – the 25% cap is on your self-employed earnings, not your total income.
Here’s a quick example. Say you earn $60,000 at your 9-5 job, and you flipped a house or two last year to earn another $28,000. You can create a SEP IRA and contribute up to $7,000 to it (25% of $28,000). For a taxpayer under 50, that contribution is a full $1,500 more than would be allowed in a traditional IRA.
3. Explore the New 20% Pass-Through Deduction
Once again, this is an opportunity for the self-employed and entrepreneurs.
Under the Tax Cuts and Jobs Act of 2017, business owners (even solopreneurs who just have a side hustle and an LLC) can deduct 20% of their net business income. Actually, it’s a little more complicated than that, because nothing is ever straightforward with the IRS. Technically, business owners can deduct the lesser of:
- Your “combined qualified business income”
- 20% of the excess of taxable income over the sum of any net capital gain
There are also income limitations in place for certain types of businesses. If you earn more than $157,500 as a single filer or $315,000 as a married couple, you may not be able to take the pass-through deduction.
But the bottom line for most small business owners is that they can slice 20% off their taxable profits. Best of all, you don’t need to itemize in order to take this deduction!
4. Deduct Medical Expenses, if Over 7.5% of Your AGI
The IRS allows you to deduct medical expenses, if they exceed 7.5% of your adjusted gross income (AGI).
Deductible medical expenses include:
- Health insurance premiums
- Preventative care
- Healthcare treatment costs (e.g. visits to the doctor’s office)
- Prescription medications
- Dental care
- Vision care
- Psychologist/psychiatrist visits
- Medical “appliances” such as glasses, contacts, false teeth, hearing aids, etc.
- Travel expenses to get to and from medical treatment locations
But there are some health-related expenses that are not deductible:
- Non-prescription medications (except insulin)
- Cosmetic procedures
- Diet or nutrition supplements
- Any expenses reimbursed by your insurance
There is a catch though – you have to itemize your deductions to take advantage of this particular tax benefit.
5. Deduct Self-Employed Health Insurance Costs
Ready for some better news, if you’re self-employed?
Self-employed taxpayers can deduct health insurance premiums from their taxable net business revenue, even if they take the standard deduction.
Better yet, you can also deduct your spouse’s health insurance premium, and your children’s health insurance costs. But only if you and your spouse were not eligible for an employee-sponsored insurance plan.
One last note: this deduction is month-to-month, meaning that if you had employer-sponsored health coverage for seven months of the year, then quit to start your own business, you can deduct the self-employed health insurance costs for that latter five months of the year when you were, in fact, self-employed.
6. Higher Education Tax Credits
If you paid college tuition for yourself, your spouse, or your children, you may qualify for one of two tax credits: the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit.
And unlike a tax deduction, a tax credit comes directly off your tax bill. No itemizing required!
The AOTC is up to $2,500 per student, per year. You can claim 100% of the first $2,000 in tuition or book costs, and 25% of the next $2,000, for a maximum of $2,500.
Living expenses such as room and board do not count toward the credits.
It’s worth mentioning that there are income limits, and the AOTC starts to phase out for single taxpayers with AGIs over $80,000 and for married taxpayers with AGIs over $160,000.
7. Do a 1031 Exchange
Sold an investment property last year?
You could pay taxes on your profits. Or you could take the profits and reinvest them in a new investment property, as a “like-kind exchange” according to Section 1031 of the tax code.
It’s worth noting that the taxes don’t just disappear, they simply defer to a later date, when you sell the new property. Say you earned $25,000 after selling a rental property this year – instead of paying taxes on it, you use it as a down payment on another, larger rental property. If you never sell that property, you never have to pay taxes on it.
If you do eventually sell that property, you can either pay taxes on the gains, or you can re-invest the gains on another even more lucrative property, ad infinitum.
It’s a great way to snowball your real estate investments tax-free, by continuing to roll over your profits into properties that generate increasingly higher rental income for you.
There’s no substitute for professional advice. The higher your income and net worth, the more complicated your taxes become, and the more potential opportunities you have for reducing your tax burden.
Consider speaking with an accountant or other tax professional if you’re self-employed or are thinking about taking any of the tax breaks outlined above. It could end up saving you far more in taxes than the cost to hire them!
Use our Choosing Wealth Calculator to figure out exactly how much wealth your projected tax savings could generate for you, over the course of a decade or two. Tax savings is a great example of how immediate gains can snowball into long-term wealth.
What’s your favorite way to save money on taxes?