5 Tax Tips for 2018 -- and Beyond
We're only in September, so tax planning may be the furthest thing from your mind. However, smart tax preparation is a year-round effort, not just something you do for a few weeks at the end of the year and when you file your tax return.
With that in mind, here are five tax tips that can help you lower your tax bill in 2018 and beyond, and that can also help you take full advantage of tax reform.
Adjust your withholdings
This one is especially important now that the U.S. tax code has undergone a major overhaul. The Tax Cuts and Jobs Act made several changes that could make your ideal withholding amount somewhat different. To name just a few, the elimination of the personal exemption, the increased standard deduction, and the higher Child Tax Credit could affect your withholdings.
Here's why this is important. The goal when setting your paycheck withholdings is to estimate your actual tax liability as accurately as possible. Obviously, nobody wants to owe thousands of dollars at the end of the year. On the other hand, a massive tax refund simply means that you gave the U.S. government an interest-free loan of your money instead of getting it along with your paychecks throughout the year.
Combine deductions into the same year whenever possible
When possible, one effective tax strategy is to prepay certain tax items or move some deductible expenses into the current tax year in order to maximize your deduction. I'll give you a few examples.
It's well known that mortgage interest is deductible on your tax return, up to a certain limit. By choosing to make your January 2019 mortgage payment before the end of 2018, you could have 13 months of mortgage interest to deduct in 2018 –- not 12.
For another example, I have a tax-deductible membership with a certain nonprofit organization, which renews on Jan. 31 each year. By paying my 2018 membership dues in January 2018 and paying my 2019 membership dues in December 2018, I'll be able to use two years' worth of my deductible membership fees on my 2018 tax return.
Max out your tax-deferred retirement contributions
The average American worker contributes a little more than 6% of their salary to their employer's retirement plan. While this is a good start, it isn't likely to be enough. Most financial planners (myself included) suggest a minimum retirement savings contribution rate of 10% of your salary -- not including employer-matching contributions.
The good news is that contributions to retirement accounts can significantly reduce your taxable income. For 2018, you can choose to defer as much as $18,500 of your salary into your 401(k) or other qualified retirement plan, and if you're over 50, this increases to $24,500.
If you don't have an employer-sponsored retirement plan, you can contribute (and deduct) as much as $5,500 to a traditional IRA, with 50-and-older savers allowed an additional $1,000 catch-up contribution.
As a final thought, if your taxes are low right now, a Roth IRA could be a smart move for you. You won't get a current-year deduction, but your eventual withdrawals in retirement can be 100% tax-free.
Save your medical receipts
One provision of the Tax Cuts and Jobs Act temporarily reduced the threshold for the medical expense deduction from 10% of AGI to 7.5% for all Americans. So, if you earn $50,000 in 2018, you would previously have been able to deduct medical expenses in excess of $5,000. Now your threshold has dropped to $3,750.
So it's a good idea to start keeping better track of your unreimbursed medical expenses. Every time you pay a co-pay, go to the dentist, buy a medication, or otherwise spend money on healthcare, save your receipt. You may be surprised at how much you're actually spending on out-of-pocket healthcare costs.
Do some tax planning with your investments
As a final tip (actually, two tips), I'd suggest minimizing your investment-related taxes. As the year goes on, here are two important concepts to keep in mind:
First, long-term capital gains are taxed at much more favorable rates than short-term gains. The IRS defines a long-term gain as one on an investment held for at least a year and a day. As an example, if you're in the 32% marginal tax bracket, earnings from a stock you sell at a profit after holding it for 11 months would be taxed at that rate. On the other hand, holding on to it for more than a year would result in a 15% long-term capital gains tax. This could translate into big tax savings.
And on a related note, it's important to remember that any capital gains you have can be offset by selling other investments at a loss, a concept known as tax-loss harvesting. For example, if you sell one investment at a $2,000 profit but sell another at a $1,500 loss, your taxable capital gain would only be $500. Long-term losses are used to offset long-term gains first before they can be applied to short-term gains or other income, and you can read a thorough description of tax-loss harvesting that I wrote last year if you want to learn more. The point is that if you're sitting on a losing investment and have been thinking of cutting your losses and moving on, using it to offset your capital gains tax could motivate you to finally sell and redeploy that capital elsewhere.
The $16,728 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,728 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.
The Motley Fool has a disclosure policy.