The Only Thing Guaranteed in Life is Death and Taxes
So if Taxes are guaranteed – why aren’t more financial gurus talking about them? I am simply amazed how little most people think about taxes or realize the impact decisions can have on their taxes.
How Big Is Your Tax Bill – Do You Know?
The first step towards realization for most people is understanding what a large chunk of your pay goes to taxes.
For me – it is one of my largest single bills – higher than my mortgage which is my largest bill. This has been true for quite some time for me – and it likely is for you as well especially if you are filing in single status.
If you need a refresher on the components of your income see my post: The Framework: Your Life as a Profit and Loss Statement and Balance Sheet
After you have done the math you likely will realize you are in the 20%+ range:
- 7.65% for social security: Rates Here If You Want Proof
- 12%+ for income taxes: Rates Here For Reference
I have seen several calculators out on the web post the Trump driven tax reform – This is the best calculator I have found
Raw Dollar Tax Amount
While the above focuses on %s – I highly encourage you to equate this number to a monthly raw dollar cost like I suggest here: The Framework: Your Life as a Profit and Loss Statement and Balance Sheet
As stated above – when framed this way – where does your tax bill rank? Is it your number one bill like me? Second? I bet it is one of your highest.
Ok What To Do About It
There are three types of tax deductions:
- Above the Line Deductions Lowering your Adjusted Gross Income (AGI)
- Below the Line Deductions Lowering your taxable income
- Tax credits – basically discounts to your tax bill
Corporations typically have massive tax departments to manage this expense and from a personal finance point of view you should also give it consideration and not just blow off this expense as out of your control.
Your goal should be to MAXIMIZE these deductions as much as you can. This isn’t being a “tax cheat” it is making sure you are maximizing what the law allows you to deduct so your personal profit and Loss Statement has more profit growth.
Quick illustration
- Gross Income From Your Paycheck
- MINUS: Above the line deductions (401k, 401g, HSA, FSA, and Child/Elder care account) – all of these BYPASS the 7.65% social security taxes
- MINUS: Above the line deductions (Student Loa, teacher deductions, farm deductions, etc) – called out below that do not by pass the 7.65%
- EQUALS: Adjusted Gross Income
- MINUS: Below the line deductions – Standard Deduction, Itemized Deductions
- EQUALS: Taxable Income
- MULTIPlED: By Your Tax rate
- EQUALS: Tax Bill less any credits you are owed
Above the Line Tax Deductions Rule
If you can afford to swing these deductions these deductions are the most powerful as they ARE NOT restricted to the itemized deduction rules which are much more restrictive now. These are also items YOU need to make a decision on before tax season.
I have further references below, but I would emphasize:
- If you have access to a 401k or 401g – put enough into your account to get the company match
- If you have access to an HSA – max out your contributions here second. No one wants to not have money for medical bills and these funds are accessible tomorrow if you need them penalty free for healthcare. If you get excess funds here you can investment those funds just like a 401k. HSAs are better than 401ks – period. They should be maxed out first.
- If you don’t have access to an HSA – you likely have access to an FSA account. This is a “use it or lose it account” – be very careful what you push into this account.
- If you have room in your monthly finances then max out your 401k or 401g.
- Keep records of anything that can qualify for an above the line deductions which are listed below for reference in detail. If you qualify for one of these you likely are already locked into these deductions and don’t need to be proactive but that doesn’t mean you shouldn’t know what these are.
- DO NOT go for the Roth IRA or Roth 401k. No one says it better than this blog post: The Case Against The Roth 401k
Below The Line Tax Deductions
For most people the revised 2018 tax law will restrict everyone to the Standard Deduction Amounts. The standard deduction amounts are $12,000 for individuals, $18,000 for heads of household, and $24,000 for married couples filing jointly and surviving spouses.
You will need more deductions than the above to deduct a below the line deduction. Eg – if you don’t have deductions in excess of $12,000 and you are single (or $24k and married) you get Zero tax benefit from donating. If you have something worth something: sell it on eBay vs donate. See my article here on why you should always be selling something on eBay and how.
The list of items you can deduct is long…. if you are over this standard deduction threshold you should know what is on the list. This is most concise checklist I have found: Itemized Deductions
Key Take Aways I would Emphasize
- If you are making $50k+ a year and not using a tax software like H&R Block or Turbo Tax you are likely missing out on some sort of tax deduction or break. Pay the $50 and make sure you are getting the advice you need. You likely can do your own taxes. They will ensure you get any tax credit you are owed!
- Maximize your use of above the line deductions. Know what they are.
- If you don’t typically have enough deductions to cross over the standard deduction – sell your stuff on eBay or donate knowing you are not getting a tax deduction.
- Be aware of all the deductions you can have if you can itemize. When in doubt, keep a receipt and answer the questions in your tax program later.
- Get out a folder or a box – shove all your tax receipts in here during the year. Just get it all in once place. It will make your life easier during tax time.
- In over your head? Find a CPA and get professional advice for your situation. He or she will still ask you for that box at #5 though!! Turbo Tax: The Number 1 Tax Software
The Following Is a Copy/Paste from Investopedia on Above the Line Tax Deductions For Refrence
Their website is Here If You Want To Read Their Full Article
Domestic Production Activities
Up to 6% of activities related to the domestic production of certain goods or services (such as engineering or architectural) may be deducted under certain conditions.
Moving Expenses
The costs of transporting household goods from one residence to another are usually fully deductible, provided that they are not reimbursed by the taxpayer’s employer. The move must be made for work or business reasons, and the taxpayer’s new place of employment must be at least 50 miles further away from the taxpayer’s previous residence than the previous workplace was from there.
Retirement Plan Contributions
All contributions made to traditional IRAs and qualified plans such as 401(k), 403(b) and 457 plans are deductible. Taxpayers with incomes above a certain level who contribute to both a traditional IRA and a qualified plan are subject to a graduated phaseout reduction on the deductibility of their IRA contributions. This deduction is not available for contributions to Roth IRAs or retirement plans of any kind. (Learn more in 3 Retirement Account Rules To Know.)
HSA, MSA Contributions
All contributions to Health Savings Accounts and Archer Medical Savings Accounts are fully deductible. However, the taxpayer cannot have access to any kind of group policy coverage, including that offered by fraternal or professional organizations. The purchase of a qualified high-deductible health insurance policy is also required.
Health Insurance premiums
The cost of premiums paid for individual health insurance policies (including high-deductible policies) are fully deductible for self-employed taxpayers. As with HSAs and MSAs, the taxpayer cannot have access to group health coverage of any kind.
Self-Employed Business Expenses, SE Tax
Virtually any expense incurred in the operation of a sole proprietorship is deductible on Schedule C, such as rent, utilities, the cost of equipment and supplies, insurance, legal fees, employee salaries and contract labor. This also includes one-half of the self-employment tax that must be paid on this income. Although these expenses are not listed directly on the 1040 but are carried to the income section via the Schedule C, they are still considered to be above-the-line deductions because they are subtracted in order to determine adjusted gross income.
Alimony
Payments made to a spouse pursuant to a divorce decree that are not classified as child support are usually counted as alimony. All payments of this type are deductible from gross income.
Educator Expenses
These include unreimbursed qualified expenses of up to $250 ($500 for joint filers if both are in this category). Qualified expenses include teaching equipment, supplies, books and other ordinary expenses that are commonly associated with education. This deduction is available for education professionals who teach grades K-12 and work at least 900 hours during the year.
Early Withdrawal Penalties
Any penalties paid for the early withdrawal of money from a CD or savings bond that is reported on Form 1099-INT or 1099-DIV can be deducted.
Student Loan Interest
All interest paid on federally-subsidized student loans up to a certain amount is deductible, provided the taxpayer’s income does not exceed $75,000 for single, head-of-household or qualifying widower filers or $150,000 for joint filers.
Tuition and Fees
In some cases, it is more advantageous for taxpayers to deduct the costs of tuition, fees and other educational expenses paid to qualified educational institutions rather than claim one of the educational tax credits for them. Those who are unable to qualify for these credits for any reason can take this deduction instead as well
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