For many people, the end of the year is a time of celebration. From December 24th through January 1st, millions of us will celebrate with family and friends to ring in the New Year.
But for some, it can also be a time of financial stress because they’ll have to pay taxes on all their income earned throughout the year, including bonuses from work or investment gains. And if you are self-employed, filing your tax return this April can mean dealing with an even heavier tax burden than usual. This article discusses five strategies to help reduce your tax burden.
#1. Tax Loss Harvesting
Tax-loss harvesting is the process of selling securities at a loss in order to offset taxable capital gains. It is an important year-end tax-saving strategy that can be used to reduce your taxes and improve your portfolio’s performance.
There are several things to keep in mind when implementing a tax-loss harvesting strategy. First, you need to make sure that you don’t violate the “wash sale rule” by buying back the same or similar securities within 30 days before or after selling them.
Here are two ways to implement tax-loss harvesting:
- Sell investments at a loss and use the proceeds to offset any taxable gains elsewhere in your portfolio.
- Deduct losses from investment sales against income from other sources, such as your job or business. This can reduce your taxable income and save money on taxes.
#2. Defer income and accelerate deductions
Another way to reduce your taxes is to defer income and accelerate deductions. This can be done by delaying the receipt of income until next year, or by prepaying expenses that can be deducted in the current year.
For example, you could delay receiving a bonus until next year, or pay your January mortgage payment in December. These types of strategies can help reduce your tax bill for this year and save money on taxes.
If you have a business, you could "frontload" your expenses, and pay bills you know you are going to pay next year - this year.
#3. Donate appreciated securities
Donating appreciated securities to charity can help reduce your tax bill. Not only are you making a laudable charitable donation, but you're also avoiding paying capital gains taxes on the investments that were given away.
#4. IRA/401k/HSA Contributions
For those who haven't maxed out their tax-advantaged retirement accounts, it's a good idea to contribute just before year-end. This way, the contribution is subtracted from your income for this year and will reduce your taxable income. Depending on your income level, you may also get an "earned income" tax credit.
In addition, if you're self-employed or own a business with employees, consider making contributions to their retirement accounts as an employer to take advantage of additional write-offs.
#5. Roth Conversion
If you have room left in your current tax bracket, and it’s less than what you think it will be in retirement, consider converting tax-deferred accounts, such as a Traditional IRA or 401(k) to a Roth. This will allow you to pay taxes on your retirement accounts this year (at your current lower rate) and grow the remaining balance tax-free for retirement.
To learn more about this strategy, check out my guide "The Ultimate Guide to Paying 0% in Taxes in Retirement."
Remember, as Benjamin Franklin said. "Aa penny saved is a penny earned."
So, as we go through this holiday season, spending money on the people we love, let's also keep our eyes on ways to save money on our taxes. These tips can help make the New Year a little less stressful, financially.
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