“It’s not just how much you make that matters, but also how much you actually keep.”
There are but few words in the financial vocabulary that strike fear in me, and TAX is one of them. The annual chore of preparing and organizing my financial documents that comes around February or March never fails to raise forth in me just a tad bit of anxiety, perhaps because at the very end of the exercise, I find out, like in every single year of my existence as an income generating individual, that I will once more pay out some painfully enormous sum from my coffers. In my opinion, it is indeed an enormous sum, which to me, was just getting comfortable where it was situated, kicking off a few nice rounds of interest and dividends.
I have but once in my life — just once!– been blessed with a tax refund. And that was on the very first year of my professional career when I was still on 1040-EZ. So like a chronic condition that I need to live with for eternity, taxes are something that I try to manage as well as I can.
How much tax do I pay? I just know it takes out a good 30% of our household income each year. I don’t even bother with the marginal bracket calculations anymore. I just know it’s 30% out the door, or more! — depending on whether I had to pay some penalty or the dreaded alternative minimum tax (AMT) thanks to the huge swings in income we’ve experienced in some years.
The big tax breaks are found in the realm of business and real estate, and because I haven’t been a small business owner for too long nor have I been much of a real estate investor, I am reserving discussion of those topics for another time. But if you are employed, here are some tax-related tips you can use to mitigate the tax hits that come your way:
- Participate in your employer’s benefit plans for pre-tax treatment on the following:
Commuter Benefits
I have to pay for parking or mass transit on a regular basis, and by participating in a commuter pre-tax program, I save $1,000 a year on commuter fees.Group Life Insurance
Some employers offer life insurance plans and when they do, the premiums can be pre-taxed.Group Long-Term Disability Insurance
This can be pre-taxed as well if this is available to you as an employee, and I’ve actually seen group premiums that were such a bargain that it would be a crime not to purchase the insurance.Flexible Spending Plan for DayCare
Sign up for a flexible spending account. You will need to estimate how much you are going to spend because any unused amount is not returned to you. You could save a mint if you pay for daycare. In my neck of the woods, daycare is around $600 a month. That amounts to over $7,000 a year. Tax Savings: over $2,000 a year.Flexible Spending Plan for Medical Costs
Estimate how much your family spends for health services, medications and prescriptions not covered by your health insurance, and apply for a flexible spending account that will cover these expenses.Charitable Contribution Matching
If you need to be in the good graces of your school community and your employer, participate in community drives and donate to schools and charities of your choice. The great thing is that if your incredibly magnanimous employer has an organized program for this sort of thing, it may not only be tax deductible or — you guessed it — pre-taxed, but it may also be a matchable contribution! Plus you’ll pick up some karma points. -
Don’t pass up the free money: contribute to a 401K Plan!
Yes you’ve heard this all before. But I am still stunned that some of my own friends who can afford it, deliberately ignore the 401K benefit: why? because retirement is just “too far away”, they won’t be in the U.S. by the time they retire, they have “better use” for their money (like buying more stuff), they never plan to retire, or their house is their retirement plan. Understandably, it may be tough for some to find the money to save, but even small regular contributions make a difference in a tax deferred plan. If you and your spouse are both working, you can contribute up to $15,000 each. If you are over 50, you can contribute up to an additional catch up amount of $5,000. However, contribution limits can also be established by your employer so you’ll need to check on their guidelines. Seems like you can contribute at most up to the limit set by the government or by your employer, whichever is less. And if it’s available to you, there’s nothing more enticing than free money with that employer match. - Build up your Roth IRA or Traditional IRA.
The 2006-2007 IRA limits for those 49 and under is $4,000, while it is $5,000 for those 50 and above. -
Donate your unwanted stuff to the Salvation Army or Goodwill.
Don’t throw away your surplus, unwanted items; recycle them and give them to charity for tax deductions! Again, I know people who don’t bother. They go the hard route by planning garage sales which in themselves can be overwhelming. So they procrastinate and then give up and rent a dumpster. But why? The Salvation Army does pick ups after all. If they don’t pass by your neighborhood, you can still drop off your stuff at donation collection hubs; it’s probably still less effort than dealing with a dumpster. -
Open 529 accounts for your dependents.
A 529 savings plan account grows tax deferred just like a retirement account does so this would be a great idea if you’re planning to pay for college anyway. For some plans, the funds from a 529 account may be used towards internationally accredited schools, even if your dependents no longer reside in the U.S. The tax-free gift limit is now up to $12,000 per giver so that you and your spouse can each give up to that amount to each account without triggering the gift tax. -
Good: Start a home business, Better: Get into real estate, Best: Get into a real estate business.
Any book I pick up about tax management never fails to point out that real estate and business are where you’ll be able to apply the best tax strategies. So that’s something to consider.
There’s just no escaping paying the tax man, but you can definitely optimize what you pay out. The breaks are out there but the challenge is to find them and to execute! Easier said than done sometimes.
By no means am I a tax expert, but I have laid out what are basic tips I follow for my own tax management efforts.
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{ 3 comments… read them below or add one }
I’m going to come look at this when my status as temp.freelancer transforms into fully employed working person.
I got my first full paycheck from the temp agency last week and a THIRD was taken out for taxes. And that was with three or four exemptions for head of household, a dependent, etc.
I have got to figure out how to flip myself out of the daily grind of barely getting by to the magic of comfortably well off.
Barely getting by can be temporary if you manage it correctly. Once you develop marketable job skills you will be able to either negotiate a nice raise or move to another higher paying position at your firm. I know people who have stayed at the first company they ever worked for and now earn $200K plus. Others take their skills and move to consulting firms and work at client sites where the pay rate is $40-50 per hour with only a few years of experience. $90-120 per hour with 10 years or more experience. The mistake is staying at a current low-paying position because you like where you live. Don’t let geography stop you from succeeding.
It stands to reason that if you are going to ask the top 10 percent of income earners to foot over 50 percent of the tax bills, then when it comes time to cut the taxes and return the surpluses.