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How to Reduce Tax Liability Without Itemizing

Post Written by: Chris Rice, CFP®, CPA/PFS

It is that time of year again! Time to think about reducing your tax liability.

Time to gather your tax documents and think about what may have changed since last year that you’ll need to incorporate on this year’s return. It is also a good time to consider what you can do to lower your tax bill, either for this year or proactively planning for next year. The Tax Cuts and Jobs Act (TCJA) was the largest tax reform bill in more than three decades. One of the biggest changes it brought about was its increase to the standard deduction. As you can see in the table below, the standard deduction increased dramatically between 2017 and 2018 and has increased steadily since then.

historical standard deduction

What Does This Mean for the Average Taxpayer?

When it comes to calculating your taxable income after determining your adjusted gross income, you have two broad choices. You can either take the standard deduction (above) or itemize your deductions. Since it’s best to take the highest deduction possible, you will only itemize deductions if they are a greater amount than the standard deduction for which you are eligible.

Since the 2018 tax year, most taxpayers have been defaulting to the standard deduction because they simply do not have enough itemized deductions to use (see table below). This means that deductions such as charitable contributions, medical expenses, state and local taxes, real estate taxes, and mortgage interest no longer have as much of an impact on your tax bill.

The income group used in this table is referring to the percentile of each group in regards to U.S. Household income figures. For instance, the “99% to 100%” group represents the top 1% of income earners in the U.S.

percentage of itemizing taxpayers by income group

How Can You Reduce Your Tax Liability without Using Itemized Deductions?

  1. Increase your Pre-tax Retirement Account Contributions

Whether you have a 401(k), 403(b), or a 457(b) you can increase your contributions (subject to annual dollar limits) and accordingly decrease your taxable income. Decreasing your taxable income is just another way of claiming a tax deduction! The only difference is instead of reporting it as a separate item on your tax return, it is deducted from wages reported on your W-2.

Even if your employer or your spouse’s employer does not offer a retirement account, you may still be able to contribute to a Traditional IRA and may be able to claim a deduction if you do not exceed modified adjusted gross the income phase-out limits in the chart below.

Married couple chart

 

  1. Open a Health Savings Account (HSA), Health Care Flexible Spending Account (FSA), or a Dependent Care FSA

 If you are already paying medical bills or paying for any type of daycare or after school care expense, it may make sense for you to open one of these accounts.  To be able to pay these expenses on a pre-tax basis rather than deferred-tax basis.

HSA

If offered through your employer, any contributions to these types of accounts (subject to certain maximum dollar amounts) are deducted from your taxable earnings. However, any proceeds from these accounts must be used for eligible expenses. If you use any proceeds from an HSA for ineligible expenses, you must report the amounts as taxable income and may be subject to an additional tax penalty.

One advantage of HSAs over Health Care FSAs is the amount contributed in a given year can be carried forward year to year.

Even if you are not paying medical bills currently, it may make sense for you to fund an HSA. Balances can be carried forward year to year and thus make the HSA another tax-deferred savings vehicle for future medically related expenses.

Health Care FSA

This account is very similar to an HSA, except the funds must be used for expenses incurred within the plan year. With Health Care FSAs it is a “use it or lose it” situation. If you do not use all the funds in a given year the funds go to your employer, who can split it between FSA participants, or use it as part of the administrative cost of servicing the plan.

Dependent Care FSA

Dependent Care FSAs are similar to Health Care FSAs, but the main difference is the type of expense an FSA fund can pay. Instead of covering medical bills, this account can pay for daycare, after school childcare expenses, babysitting, day camp, a nanny, and nursery or preschool, to name a few. However, the expenses are qualified by allowing the parent(s) to work while their child is being cared for.

  1. Other “Above the Line” Deductions

There are other deductions outside of itemizing you can claim. However, these are more a result of your life circumstances rather than a choice you can make going forward to reduce your tax liability.

Alimony Paid

Any alimony you pay is deductible on your tax return. This deduction technically was phased out under the TCJA. However, if your divorce was final before December 31, 2018, you are still eligible to deduct your alimony paid.

Student Loan Interest Deduction

You can claim a deduction of up to $2,500 per year for any interest paid on qualifying student loans. A qualifying loan is for the benefit of you, your spouse, or your dependent.  Loans from an employer plan or private loans from a friend or family member do not qualify. This deduction has modified adjusted gross income phaseouts for 2019 as outlined below.

phaseouts

 

These are just a few ideas for lowering your tax bill and reducing your tax liability even if you don’t itemize deductions. Whether you can make a difference for the 2019 tax return you are about to file or make a change that will help you save in the future, now is a good time to discuss your tax situation with your tax accountant and financial advisor. If you don’t have a financial advisor or are looking for one who brings expertise such as tax-savvy planning and an emphasis on helping you reach your goals, get in touch with Domani Wealth today! We’re known for listening to you and providing real-world, practical advice.

 

 

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