Cutting Your Tax Bill Before End-of-Year

An unexpected tax bill can ruin your day. To help avoid that unwelcome surprise, here are some easy moves many people can make to cut their tax bills. In many cases, you must itemize rather than take the standard deduction in order to use these strategies. The extra effort may be worth it.

1. TWEAK YOUR W-4

The W-4 is a form you give to your employer. It instructs on how much tax to withhold from each paycheck.

• If you got a huge tax bill this year and don’t want another surprise next year, raise your withholding so you owe less when it’s time to file your tax return.
• If you got a huge refund, do the opposite and reduce your withholding — otherwise, you could be needlessly living on less of your paycheck all year.
• You can change your W-4 any time. 

2. STASH MONEY IN YOUR 401(K)

Less taxable income means less tax, and 401(k)s are a popular way to reduce tax bills. The IRS doesn’t tax what you divert directly from your paycheck into a 401(k).

• For 2020, you can funnel up to $19,500 per year into an account.
• If you’re 50 or older, you can contribute an extra $6,500 in 2020.
• These retirement accounts are usually sponsored by employers, although self-employed people can open their own 401(k)s. And if your employer matches some or all of your contribution, you’ll get free money to boot.

3. CONTRIBUTE TO AN IRA

You may be able to deduct contributions to a traditional IRA. How much you can deduct depends on whether you or your spouse is covered by a retirement plan. Also, it depends on how much you make.

• For the 2019 tax year, you may not be able to deduct your contributions if you’re covered by a retirement plan at work, you’re married and filing jointly, and your modified adjusted gross income was $123,000 or more. In 2020, that number rises to $124,000.

There are limits to how much you can put in an IRA, too:

• For 2019 and 2020, the limits are $6,000 per year, or $7,000 for people 50 or older.
• You have until the tax-filing deadline to fund your IRA for the previous tax year, which gives you extra time to take advantage of this strategy.

4. SAVE FOR COLLEGE

Setting aside money for Junior’s tuition can shave a few bucks off of your tax bill, too. A popular option is to make contributions to a 529 plan, a savings account operated by a state or educational institution. You can’t deduct your contributions on your federal income taxes, but you might be able to on your state return if you’re putting money in your state’s 529 plan. Be aware, too, that there may be gift tax consequences if your contributions plus any other gifts to a particular beneficiary exceed $15,000.

5. FUND YOUR FSA

The IRS lets you funnel tax-free dollars directly from your paycheck into your FSA every year, so if your employer offers a flexible spending account, you might want to take advantage of it to lower your tax bill.

• In 2020 and 2021, the limit is $2,750.
• You’ll have to use the money during the calendar year for medical and dental expenses, but you might also be able to use it for related everyday items such as bandages, pregnancy test kits, breast pumps and acupuncture for yourself and your qualified dependents.
• Some employers might let you carry money over to the next year. 

6. SUBSIDIZE YOUR DEPENDENT CARE FSA

This FSA with a twist is another handy way to reduce your tax bill — if your employer offers it.

• The IRS will exclude up to $5,000 of your pay that you have your employer divert to a Dependent Care FSA account, which means you’ll avoid paying taxes on that money. That can be a huge win for parents of kids under 13, because before- and after-school care, day care, preschool and day camps usually are allowed uses.
• Elder care may be included, too.
• What’s covered can vary among employers, so check out your plan’s documents. 

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Source: Nerdwallet