Even if you've already earned most of your income for the year, you can still make some common-sense moves to reduce the amount of income taxes you owe in the current tax year.
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As the year ends, you may feel it's too late to save any money on taxes. However, even if you've already earned most of your income for the year, you can still make some common-sense moves to reduce the amount of tax you'll owe. If you own a business, you have access to an even greater variety of ways to reduce taxes.
Generally, the longer you can wait to pay taxes, the better. Deferring income from the current year into the next is one way to delay paying taxes and reduce the current year's taxable income.
For example, if you're an employee and you're due a year-end bonus, you can ask your employer if they're willing to push that payment into next year. Although this strategy can save taxes in the current year,
- Deferred income may create tax problems the following year, particularly if you find yourself in a higher tax bracket.
- You'll have to balance any current tax savings with the taxes you'll have to pay in the future.
- However, if your priority is to reduce this year's taxes, the less income you can realize in the current year, the better.
Make an IRA contribution
Contributions to a traditional individual retirement account can be tax-deductible in the year you make them. Different IRS rules on IRA contributions apply to differing situations. However,
- You can generally deduct the full amount of an IRA contribution if you and your spouse aren't covered by retirement plans at work.
- If you and your spouse are covered, your contribution might be limited based on your adjusted gross income.
For example, if you are in the top tax bracket of 37% and make a $6,000 deductible contribution—the maximum for 2020—you can save as much as $2,220 in taxes based on 2020 tax rates. Best of all, unlike most tax-saving strategies that must be in place by December 31, you can contribute to an IRA all the way until tax filing day, typically April 15.
Take capital losses
If you lose money on a capital investment, such as a stock, you can use that loss to reduce your taxes. But you’ll have to sell the stock at a loss first, a process known as "realizing" a loss.
- Once you realize a loss, you can use it to offset any realized capital gains you may have.
- If you have more capital losses than gains, the IRS allows you to use up to $3,000 of excess loss to offset your ordinary taxable income.
The IRS will disallow your loss for tax purposes in the case of a "wash sale." A wash sale occurs if you buy back the same investment or one that is near identical within 30 days before or after taking a tax loss.
Coupled with the offset of your capital gains, taking capital losses can wipe out a significant amount of your tax liability.
If you own a business, you can take a deduction for a wide range of business-related costs. If you're keen on reducing this year's income taxes, bunch your expenses as much as possible into the current year.
Some common business tax strategies include:
- Making any anticipated major business-related purchases at the end of the year instead of the beginning.
- Paying your employees bonuses at year-end, rather than at the beginning of the year.
- Prepaying expenses. For example, if you regularly spend $5,000 per month to buy supplies, consider buying $15,000 worth at year-end to get you through the next three months. By making a bulk purchase at year-end, you'll get a deduction in the current tax year for that business expense.