How to Reduce IRS Taxes

Save Big Money by Reducing Your Taxable Income

Guess what—some money you receive NEVER has to be included on your tax return!
That’s right—many taxpayers are unaware that you can earn money and not include it as income on your 1040. Of course, if you do report this income, the IRS isn’t going to tell you that you didn’t need to. So make sure you know about these tax-free sources of cash.

  1. If you rent property for 14 days or less per year, the rental income is completely tax-free. Say you have a summer beach house that remains unoccupied for most of the year. You could rent it out in the off-season for two weeks or for seven weekends and pay no taxes on the money you receive, no matter how much that is.
  2. Life insurance proceeds are always income tax free to the beneficiary.
  3. The first $250,000 in capital gains ($500,000 if you’re married and filing a joint return) from the sale of your home is not taxable if you’ve lived in the home for any two of the five years preceding the sale.
  4. All child support payments you receive are 100% non-taxable.
  5. The proceeds of home equity loans are completely tax-free for loans up to $100,000, and the interest portion of your loan payments is tax deductible.

In addition to these tax-free sources of cash, there are several ways to receive non-taxable money from your employe

  • Your employer can give you $250 per month for parking.
  • You can receive $100 tax-free every month to pay for commuting costs (such as mass transit passes).
  • Your boss can give you up to $5,250 for education expenses that improve your knowledge of your current job without incurring any additional income taxes. Plus, beginning in 2002 even graduate courses qualify for this special tax treatment.
  • Employer-provided group term life insurance is tax-free for up to $50,000 of coverage.
  • All of your contributions and all employer-matching contributions to your pension plan are tax-free until you withdraw the money. Be sure, however to watch for excess contributions, so you are not penalized.
  • Your employer can provide you with tax-free meals and transportation when you work extra hours.
  • If your employer has a written employee awards plan, an employee can exclude up to $1,600 for qualified awards and unqualified awards combined. The awards, however, have to be in the form of tangible personal property (hard assets) in order to qualify. Therefore, cash wage bonuses do not qualify.
  • Through flexible spending accounts, you can use pre-tax income to pay for daycare and health expenses up to a limited amount each year.



If You Invest, You Probably Have Deductible Investment Expenses That May Reduce Taxes

Whether you invest in the stock market or in real estate, you most likely incur some expenses in the process. You can deduct these expenses (even if you earn no taxable investment income in the current year), as long as you own (hopefully) income-producing investments.Investment-related expenses that can be reported on your Schedule A include:

  • Accounting, auditing and custodial services.
  • Fees to set up or administer an IRA (as long as you pay them with a separate check).
  • Investment interest management or advice fees.
  • Safe deposit box fees (when you use the box for stock certificates and other investment-related documents).
  • Subscriptions to investment services.
  • Subscriptions for publications that offer investment advice.
  • Travel expenses to meet with your broker or investment advisor.



“Tax-Manage” Your Portfolio to Reduce Your Liability

Even if you deduct your relevant investment expenses, you can still be docked when tax time rolls around. However, with a little foresight, you can lower or defer the IRS’ drain on your hard-earned profits.



Reduce Capital Gains by Minimizing Turnover

Short-term capital gains taxes can range as high as 39% The less you trade your core portfolio, the less tax liabilities you’ll incur. As Warren Buffett once said, “The capital gains tax is not a tax on capital gains, it’s a tax on transactions.” In fact, if you hold onto your winners for a year or more, any gains will be taxed as long-term capital gains, for which the maximum rate is only 20%, saving you 18.6%.The IRS allows you to offset all of your realized capital gains with realized capital losses. You can also take up to $3,000 in additional losses against all other income.



Use Tax-Deferred Accounts for Highly Taxed Investments

Index funds tend to be highly tax efficient because changes to the index are relatively rare. Managed funds often have a high turnover, and are required by Federal law to distribute at least 98% of realized capital gains each year. Again, capital gains taxes apply to transactions, so investing in index funds with low turnover in your non-qualified accounts can significantly reduce your capital gains tax burden. If you invest in managed funds (outside of your IRA or other tax-deferred account), you can be hit with a big capital gains distribution even in years that the fund is actually down.To avoid such a scenario, use your IRA, 401K, pension, or other tax-deferred accounts to own these actively managed funds. In fact, you should also use these types of tax-deferred accounts to own taxable bonds (since interest income is taxed at the same rates as earned income), utilities and real estate.



“Above the Line” Deductions Can Lower Adjusted Gross Income

Adjusted gross income (AGI) is used to calculate how much of your deductible expenses will actually be deductible. For example, only medical expenses greater than 10% of AGI are deductible. Plus, since most state taxes are based on your federal AGI, a lower amount can lower your state taxes.
Your AGI is calculated as follows:

  1. Figure out your gross income, which includes such items as salary, interest and dividends, capital gains and business income.
  2. Subtract the “above the line” deductions (meaning deductions used to arrive at AGI), which include:
  • IRA contributions
  • Up to $3,000 of a net capital loss
  • 50% of your self-employment tax liability (discussed further in the section “Special Tax Breaks for Entrepreneurs”
  • 70% of your health insurance premiums, if you’re self-employed (discussed further in the section “Special Tax Breaks for Entrepreneurs
  • Medical savings account contributions (discussed further in the section “Special Tax Breaks for Entrepreneur
  • Keogh or SEP retirement plan contributions for yourself (discussed further in the section “Special Tax Breaks for Entrepreneur
  • Alimony payment
  • Student loan interes
  • Moving expense

   3. The difference between steps 1 and 2 is your AGI


A Traditional IRA Reduces Your AGI

For tax-year 2016, you can make contributions of up to $5,500 to a traditional IRA if you are under age 70 1/2 and have salary or net self-employment earnings. The contributions count as a deduction on your 2015 taxes as long as you make it before April 15, 2016. Even if your spouse doesn’t work, you can contribute a deductible $3,000 for him or her as long as you file a joint return. The previously frozen contribution limit will continue to increase—up to $4,000 in 2005 all the way to $5,000 in 2008 (after that, the limit will be indexed to inflation).

And for those of us getting ever closer to the legal retirement age, the new tax law lets us do some catch-up funding to make up for all the years the limit was lower. If you’ll be 50 or older in 2016, you can stash an extra $1,000 in your IRA, bringing your total contribution up to $6,500. The bonus contribution limit increases to $1,000 for 2006 and beyond.

As long as neither you nor your spouse actively participates in your employer’s (or a self-employed) retirement plan, the $6,000 contribution is fully deductible. If one or both of you are covered by another retirement plan, your deduction may be limited or phased out completely.

The deduction for a traditional IRA contribution starts being reduced when your modified adjusted gross income (MAGI—basically your AGI, not including any IRA deduction, with some “above the line” deductions, such as student loan interest, added back) hits the “phase-out threshold.”

Once you reach the threshold, your deduction gets reduced for each $1,000 of your income that exceeds the threshold. If your income is $10,000 or more above the threshold, you receive no deduction at all.