“A Countdown of 10 Ways To Save On Taxes For The New Year.” I recently connected with Hannah Morgan, a personal finance blogger and half of the mastermind behind Ways to Means: a Personal Finance Podcast. Between podcast episodes, she runs a project management agency, Heron Works, which helps businesses with their fractional project and operations management needs. She has come to share a great article on ways everyday folks like you and me can save on taxes in the coming year:
Take It Away Hannah!
The countdown to the new year is upon us but there is still time to make 2022 your best tax year yet (if that’s even a thing?!). There are so many things you can do right now before the end of the year to reduce how much you pay in taxes this year and set yourself up for success in 2023.
A lot of tax tips are geared towards the wealthy because our tax code greatly favors the higher income tax brackets. You may have heard of elaborate tax loopholes, buy/borrow/die, or the 1031 exchange. All of those are designed to benefit the wealthy, but not enough attention is given to what everyday people who are not ultra-rich can do to lower their tax burden without lowering their actual earned income.
Today we’ve got 10 ways you never knew you could save on taxes. And to ring in the new year, we’re going to be counting down to our favorite one at the top of the list.
10. Not Paying Capital Gains on the Sale of a House, Up to $500k in Proceeds
Many people have heard of the 1031 exchange, a favorite tax shield of the wealthy. It is a complex way to shield earnings from the sale of one house by using the funds to buy another house. It can be used when you sell your house but you’re not in a situation to buy another house immediately after or you are downsizing to a less expensive house than the one you sold. By using it to purchase a rental or investment property you are able to put off paying taxes.
Even though not everyone is in the market to purchase an investment property you can still save on taxes if you sell your own home:
If you have lived in your house for 2 out of the past 5 years, you can claim up to $250k of the proceeds of the sale of your house, free of capital gains taxes. And if you’re married, you can each make this claim for a total of $500k in tax-free capital gains.
If there are 2 unmarried owners, you can each claim the $250k separately. This setup can allow for significant savings if you’re in the situation of downsizing or selling your home to be nomadic for a while.
9. Not Claiming Up to 15 Days of Vacation Rental Income
If you ever wanted to earn some extra income by renting out your primary residence while you’re out of town, it turns out you do not have to report that to the IRS if the total days rented is less than 15 in a year.
It is important to note that this exception is only at the federal level, but often the city or county will have its own tax on short-term rentals that is subjected to all days rented.
8. Traditional IRA (Individual Retirement Account)
An IRA is a popular tax shield because any contribution to this retirement account is pretax, so it reduces the amount of income tax you pay for the year you contribute. These are available to anyone regardless of how much income you make, but you do have to pay taxes on the income once you withdraw it.
This account can be set up directly with a custodian (Fidelity, Schwab, etc) but don’t forget to invest it! That is the most common pitfall – that people set up an account and don’t know they have to invest the funds. So if you have an IRA already, check that it’s invested now!
7. Roth IRA
A Roth IRA is a type of tax-protected retirement account that is actually geared toward people who are not ultra-wealthy. You can only contribute to the Roth if your income is less than $144,000 in 2022. That number will go up to $153,000 in 2023.
You can only contribute $6k/year if you’re under 50, but then that number goes up to $7000 if you’re over 50. That will increase in 2023 to $6500 if you’re under 50 and $7500 for those over 50. So while this should not be your only retirement account, many advisors suggest it is the best place to start as it is low-hanging fruit from the perspective of lowering your eventual tax burden.
Tax Benefits
Roth IRAs are favorable because you reap the tax benefits on the backend when you withdraw funds in your retirement years. This means that if you put $100 in now, you will pay taxes on that as income now. But when you withdraw the funds in 20 or 40 years, that $100 will have multiplied through investments, and you won’t pay any taxes when you withdraw it. If you look at a 7% return each year on average, that $100 will be $386 in just 20 years. Tax-Free!
If you have an IRA now but make too much for a Roth IRA, you can look into backdoor contributions.
It is important to note that with any retirement account, you have to wait until you have reached the eligible age, currently 59 1/2, to withdraw the funds, which may change in the future. You can pull the funds out sooner, but you will pay a penalty that can be quite hefty. If you think you’ll need the funds before retirement, consider putting them in a brokerage or high-yield savings account where you can avoid those penalties for early withdrawal. (Where To Put Your Savings)
6. Spousal IRA
This is a little-known benefit but if there is one person in a married relationship who is not working or is earning no more than $4300/year, their spouse can contribute to an IRA in their name. This is great for people who are stay-at-home parents or who are not working outside the home but still need to plan for their retirement.
One bonus that you might not think of is that the IRA is in each spouse’s name independently, so it cannot be a joint account. This may make it easier to protect those funds. (Stay-at-Home Moms, Take Charge of Your Financial Security)
5. Save on Taxes by Not Getting Married
One of the least-known hacks for saving money is NOT getting married. It may sound odd, but there is a possibility it would be cheaper to actually not tie the knot. The tax code has historically been written to favor marriage, but that is not always the case in reality.
My “husband” and I use an online calculator to figure out which scenario benefited us and this year, it came to about $2500 in savings by staying unmarried. In past years, that was much greater because our incomes were so different that it was advantageous for the lower earner to claim the kids to lower insurance subsidies and other benefits.
(Note From Mrs. Bean: Make sure to play with this calculator, it is different for every couple. In our case, where I am a stay-at-home parent, not earning much, it was more beneficial to be married.)
4. State Income Tax Credits
Many people have heard that gifts to registered nonprofits are tax deductions, but those are typically only on federal taxes. What is less commonly known is that if you give to some charities, you may also be able to apply that to your state taxes.
There are 27 states in which you can deduct or gain a tax credit for qualified gifts. In Virginia, which is where I first learned about this program, the receiving charity must be registered with the state’s Neighborhood Assistance Program which is only for nonprofits that serve low-income people. To find out if your state has this program, check out this list.
3. Save on Taxes with Above-the-Line Deductions
If you keep your taxes straightforward and do the standard deduction, this means you can’t claim quite a few common tax write-offs the way wealthy people who have CPAs to help them do. There are a few “above-the-line deductions” that you can claim on top of the standard deduction including educator expenses, contributions to an IRA, alimony, self-employed business expenses, and student loan interest payments.
2. Flexible Spending Account (FSA)
The FSA is a work-sponsored tax shield that allows you to save pre-tax income to spend on qualified medical, dental, and vision care expenses that are not covered by your health care plan or elsewhere. You may be surprised at what is eligible as an expense. Some notable ones are sunscreen, bandages, thermometers, eyeglasses, tampons, Theragun/self-massagers, Neosporin, and a first aid kit.
A few things to know about FSAs:
- Not all employers offer them, but if you work for a medium to large company, you should ask if it is offered. Some small companies may offer it as well.
- This year they are limited to $3,050 per year per employer. If you’re married, your spouse can put up to $3,050 in an FSA with their employer too.
- You can use funds in your FSA to pay for certain medical and dental expenses for you, your spouse if you’re married, and your dependents.
- The funds are use-it or lose-it which means you can’t roll over to the next year, so don’t forget about it! A note that some employer plans will offer a modified amount that can be rolled over or a grace period of a few months to use last year’s funds.
1. Health Savings Account (HSA)
The HSA is my personal favorite personal finance tool and tax hack. It is known as a triple tax savings because the money you put in is pre-tax, which means it reduces the amount of income you have to pay taxes on. So if you earn $50k but contribute $3k to an HSA, you only have to pay taxes on $47k of your income.
It is also able to grow tax-free and when you pull the money out, as long as you spend it on qualified health expenses, you don’t pay taxes on it then either. Triple benefit! And the funds roll over each year, so you can actually grow wealth that will help you in your later years when your medical expenses will be the highest.
A few things to know about your HSA:
- You can only contribute to it if you have a High Deductible health plan but this is easy to tell because it will say “HSA” in the name of the plan. I always choose an HSA-eligible plan because I have low annual health costs, so it’s worth it to me to have a higher deductible but then reap multiplied benefits in the long term.
- There is a limit to contributions and in 2022, that is $3,650 for self-only coverage and $7,300 for family coverage. If you are under 55. If you are over 55, you can contribute more to catch up.
- You can invest it! Not all plans advertise this but if an HSA is part of your long-term wealth-building plan, investing it will help it grow for when you need it in your later years.
(Note From Mrs. Bean: HSA plans are wonderful for families and individuals who are healthy and just need insurance for catastrophic events. For individuals, like me, who have major health problems and see doctors often, it is probably more important to skip the High Deductible Plans and just get really good coverage. I definitely wish I could have an HSA plan on top of full coverage medical coverage.)
Save on Taxes in the New Year Wrap-Up
These are some wonderful tax tips to take advantage of in the new year! Make sure to look into what you have available to you. Talk to your HR/Benefits department at work. Play with tax calculators. Take this list and find out what is available to you. Then Max It OUT!
What are some tax tricks for the non-ultra-wealthy that you have found useful? Make sure to leave a comment below and share your favorite articles.