There are many articles online that offer ways to reduce your taxes and most of them talk about fairly common ideas. They may say things like, start a side business, open a health savings account (HSA) at work, add to pre-tax accounts like 401k plans and individual retirement accounts (IRAs), and make gifts to charities. These are all great things to consider and there are many more that your accountant would love to tell you about, I’m sure.
What this post is going to get into are the things that are slightly less commonly found online but are still very meaningful to consider as well, as we all seek out ways to keep more of our hard-earned money.
1) Gifting assets to a charity or donor advised fund
I know, this area you have probably heard of or read about before. There are plenty of people (myself included) who encourage gifting appreciated stocks and funds to charities and donor advised funds. In fact, here’s a related article on giving: How to Give and Still Get Money Back.
The strategy of gifting appreciated assets applies once you have owned the asset for over one year, so it turns into a long-term capital gain. Well, what happens if you are within the one-year time frame, are you without options? No!
Let’s say you just purchased a stock for $5,000 that you thought was going to go up, but suddenly it drops by 50% because of a news article or earnings report and now it’s worth $2,500. There is another option besides selling it or holding on to it in hopes that it comes back up. You can choose to gift that stock to a qualified charity or donor advised fund. The value of stock goes to the charity ($2,500), but you get a charitable deduction for the value you paid for it ($5,000).
2) Opening a taxable brokerage account
Similar and related to the strategy above, you could also consider opening a taxable brokerage account as a potential way to save taxes. By owning a taxable account, it allows you to take advantage of many strategies that people who have only retirement accounts cannot. In addition to the gifting strategies already mentioned, taxable accounts have the ability to offer a $3,000 per year deduction on your taxes for any losses that you have sustained. If you had $100,000 in one of these accounts when COVID hit and the markets declined by 30%, you might have had an ability to sell, turn your unrealized loss into a realized loss, and then been able to get back into the market right away to ride the wave back up. In doing so, you would have a $30,000 deduction that can be carried forward each year and both give you a deduction yearly as well as reduce future gains. Of course you would have to be mindful of the IRS rules on this – as is always the case.
As an added bonus, having a taxable brokerage account also allows you to have funds outside of retirement accounts and this would give you the ability to consider Roth conversions, which we will revisit later on.
3) Pay more with pre-tax dollars
Believe it or not, there are legal ways that we pay for things using pre-tax dollars or money that has yet to be taxed! Some of these things you have heard of, yet some might be new options to consider.
As mentioned at the beginning, HSAs are accounts that you fund with pre-tax dollars, and then you can use the money for qualified medical expenses. That means your deductibles, Medicare premiums, and a slew of other expenses including prescriptions can all be paid for with money you never had to pay tax on. 529 college savings accounts similarly offer the ability to use pre-tax funds for college and qualified education expenses for yourself or family members.*
If you have an IRA, there are additional options for you as well. For starters, the financial planning fees on traditional, SEP, or SIMPLE IRAs are all fees paid straight out of the accounts and the government doesn’t tax you on those payments. In addition, if you are over the age of 70 and ½, you also have the ability to do Qualified Charitable Distributions (QCDs). A QCD is a gift to a qualified charity of your choosing, and the money is sent straight out of your IRA and isn’t taxable to you. The best part is that a QCD also counts as part of your required minimum distribution (RMD), so you can reduce your taxes while still being charitable.
4) Watch your spending
When we think of taxes, we often think of income tax and property tax because those are the big numbers that stand out every year. There is, however, another tax that slowly eats away at how much we get to keep of our earnings, and that is sales tax. In McKinney, Texas, where I live, the sales tax is 8.25% and that’s the combination of state, county, city, and federal tax combined. That means if you make $100,000 per year and spend $30,000 on taxable goods throughout the year, you may have paid an additional $2,475 in taxes for the year on top of your income and property taxes. So how can we reduce that number?
For starters, reconsider buying new vehicles. If you purchase a new car for $50,000 versus a pre-owned one with a few miles on it for $40,000, you not only saved $10,000 in the purchase price, but you also saved an additional $825 in sales tax.
Next, look online in the private marketplace for big ticket items. If you can purchase the new $500 PlayStation video game system for your children by getting it from someone directly who has a barely used one, you again save on the price but also on the sales tax.
Last, go to restaurants less and cook more. This is something many of us have gotten used to with COVID shutting down places, but there is an added benefit. In many states, food products are not taxable when you get the individual components from the grocery store, but the meal is taxable when served from a restaurant. Here’s a link to see what falls into which category in Texas: Texas Comptroller Grocery and Convenience Stores Taxes.
5) Consider long-term tax planning
Often when we look into ways to reduce taxes, we are looking for a quick fix to see what we can do today to reap the benefit today. Many times, that can be shortsighted. If you find you have the ability to reduce your taxes and only pay a 10% tax rate today, you may actually shoot yourself in the proverbial foot in your long-term planning. In the middle of 2020, I gave a webinar on the National Debt Crisis, and one of the things I addressed were historical tax rates in the United States. If you want to see the webinar check out: National Debt Crisis Webinar and you can skip to the time 16:53 if you’d like to see the tax rates historically.
Everyone’s situation is specific to them, but to generalize, if today you are in a 22% tax bracket, there’s a fair possibility that you can be in a higher tax bracket in the future. You could make more money, you could lose a spouse, or the overall rates could be raised nationally (which they are slotted to do in 2026).
What you can do to take advantage of long-term tax planning is to maximize Roth accounts. If you are still working, you may want to consider contributing to a Roth IRA or Roth 401k. If you have pre-tax dollars in a 401k or IRA at any age, you may consider converting some of those funds into Roth. In doing so, you are locking in your current tax rates so in the future you don’t have to worry about changing tax rates effecting those funds. This is best done by having some money on the sidelines which ties back into point number 2 above in non-retirement accounts or an extra-large emergency fund. Roth conversions can have unintended tax consequences in eliminating tax credits and temporarily increasing Medicare premiums, so work with qualified professionals in doing so.
So, there you have it – 5 creative ways to reduce your taxes. Please reach out with any questions or if I can help you further on these. And also let me know of any other creative solutions I didn’t mention!
Please keep in mind, while I'm familiar with the topics presented here, Raymond James does not offer tax advice. Please discuss with the appropriate professional. Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Additionally, each converted amount may be subject to its own five-year holding period. Converting a traditional IRA into a Roth IRA has tax implications. Investors should consult a tax advisor before deciding to do a conversion.
* Rules and laws governing 529 plans are varied and subject to change. As with other investments, there are generally fees and expenses associated with participation in a 529 plan. There is also a risk that these plans may lose money or not perform well enough to cover college costs as anticipated. Most states offer their own 529 programs, which may provide advantages and benefits exclusively for their residents. Investors should consider, before investing, whether the investor’s or the designated beneficiary’s home state offers any tax or other benefits that are only available for investment in such state’s 529 college savings plan. Such benefits include financial aid, scholarship funds, and protection from creditors. The tax implications can vary significantly from state to state.
Investors should carefully consider the investment objectives, risks, charges and expenses associated with 529 college savings plans before investing. More information about 529 college savings plans is available in the issuer’s official statement, and should be read carefully before investing.