A. Here are top 10 ways to reduce income tax and capital gain tax:
1. Reduce Your Income Tax and Capital Gains Rates by Contributing to a Retirement Plan. Pretax contributions to employer sponsored retirement plans can reduce your adjusted gross income (AGI), which can reduce your marginal and effective income tax rates. Reducing your adjusted gross income can reduce your long term and short term capital gains rates. It may also exempt you from the ominous investment surtax (net investment income tax). Common retirement plans include: 401(k), 403(b), 457(b), pension plan, SEP IRA and SIMPLE IRA.
2. Claim Your Exemptions. Reduce your taxable income with exemptions. Typical exemptions include you, your spouse and your children under the age of 19 or students under the age of 24. Dependents may also include other relatives that you primarily support. Each exemption reduces your taxable income by $4,050. Exemptions are subject to phase-outs that begin when your AGI exceeds $261,500 for single filers and $313,800 for those married filing jointly. Exemptions phase-out at $384,000 for single filers and $436,300 for those married filing jointly.
3. Claim the Larger of a Standard Deduction or Itemized Deductions. The standard deduction for a single filer is $6,350 and for those married filing jointly it is $12,700. Itemized deductions include charitable donations, mortgage interest, state and local taxes, medical expenses and long term care insurance premiums. Itemized deductions may be capped or phased out based on your income due to the Pease limits. The Pease thresholds begin at $261,500 for single filers and $313,800 for those married filing jointly.
4. Reduce Your Income Tax Rate by Contributing to a Section 125 Cafeteria Plan. Pretax contributions to employer sponsored cafeteria plans can reduce your adjusted gross income (AGI). The reduction in AGI can reduce your long term and short term capital gains rates. The premium only plan (POP) can be used for your portion of health insurance premiums. The flexible spending account (FSA) can be used for medical expenses up $2,600. The FSA can be used for dependent care expenses up to $5,000.
5. Exercise Tax Diversification. Interest generated by fixed income investments like bonds are taxed at your income tax rate, while qualified dividends from most stocks and stock funds are taxed at your more favorable capital gains rate. Exercise tax diversification by placing income generating assets in tax shelters like 401(k)s and IRAs. Exercise tax diversification by placing higher yield dividend producing stocks and funds in tax shelters, and lower yield growth stocks and funds in taxable accounts. Your heirs will ‘appreciate’ the benefit of a step-up in their basis based on the fair market value of your investments upon your death and their inheritance.
We will discuss the next 5 tax saving tips in next blog post.