Ways To Maximize Your Tax Savings

 

Tax season is in full swing and as a financial advisor, many of my conversations this time of year are focused on ways to reduce taxes for my clients. Determining which credits and deductions you are eligible to claim will help you in maximizing your tax savings.
Tax deductions work by reducing your taxable income, while credits work by reducing the amount of tax you owe to the IRS on a dollar-for-dollar basis. In terms of tax refunds, credits typically yield a bigger return than deductions. To illustrate, let us compare a $2000 deduction to a $2000 credit for someone who pays 20% in taxes on an income of $50,000.

  $2,000 tax deduction $2,000 tax credit
Adjusted Gross Income $50,000 $50,000
 Less: Tax Deduction  -$2,000  $0
Taxable Income   $48,000  $50,000
 Hypothetical Tax Rate  20% 20% 
 Calculated Tax  $9,600 $10,000 
 Less: Tax Credit $0   $2,000
 Tax Bill  $9,600 $8,000 

 

Here are some specific ways you can maximize your deductions and credits this year.

1. Contribute to your 401(k) and/or Traditional IRA. One of the best things your can do for your finances is save for retirement. Not only will you be saving for your retirement, but you will also be able to deduct your contributions from your taxable income. The IRS sets a limit on the amount you can deduct each year: $19,500 for 401(k) contributions and $6,000 for traditional IRA contributions.

The Roth IRA is a great tool for saving for retirement as well, but because Roth IRA’s are funded with after tax dollars, they are not eligible to be used a tax deduction.

2. Contribute to an HSA Saving for medical expenses with an HSA is another opportunity to deduct a portion of your income. Health Savings Accounts are available to anyone who has health insurance coverage that includes high deductible amounts that meet federal guidelines. Contributions to your HSA are full deductible and distributions are tax-free if used for qualified medical expenses. You can deduct up to $3,600 for individuals and $7,200 for families.

3. Take advantage of tax credits. As mentioned already, tax credits will typically yield a bigger return than tax deductions so it is important to know which credits you may be eligible to claim. Below are some of the more popular tax credits.

  • Child Tax Credit – Parents of children who are 16 or younger as of Dec. 31, 2020 may qualify for up to $2,000 per child.
  • Child and Dependent Care Credit – If a taxpayer has paid expenses for the care of a qualifying child or dependent, they may be eligible for up to $3,000 of expenses for one child and up to $6,000 for two or more children.
  • Lifetime Learning Credit – This credit is for qualified tuition and expenses paid for qualified students at qualified institutions in the United States. The credit is worth 20% of the first $10,000 a person spends at a higher education institution.
  • Retirement Contribution Savings Credit – The saver’s credit was created to help low- and moderate-income individuals save for retirement. It is worth up to $1,000 for qualifying taxpayers who contribute to a retirement account.
    All tax credits have various eligibility requirements. A CPA can help you determine what credits are available in your situation.

4. Hire a CPA. The United States tax code is an extremely complex subject. While it is certainly possible to do your taxes on your own with online tools like TurboTax or HR Block, I would encourage most people to reach out to a CPA to do their taxes. A competent CPA will not just file your taxes, but help you understand which deductions and credits can best maximize your tax return this tax season.

Brad Lupkes

Brad Lupkes, CFP®
Financial Advisor
Phone: 712-472-2538
trust@frontierbk.com

 

 

 

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