Not all "tax tips" are created equal.
In fact, some are worth considerably more than others. 🤑
What you've likely heard about are what I call "low-value tactics" -- strategies that can save you some money, but not big money.
'Low-value' tax-savings tactics 🥱
Contributing to an IRA
Saving in an HSA
Buying a printer for your business
While implementing any one of these strategies will reduce your tax bill, it's not likely to make a meaningful dent.
Instead of bombarding you with a long list of low-value tactics, I'm focusing on four strategies that could significantly improve your tax situation. That is, ones that can save you thousands of dollars as opposed to a few hundred.
Note: The information immediately below applies to the tax year 2023. Please consult your tax or financial professional before carrying out any of these strategies.
1. Maximize pre-tax company retirement accounts
Fact: The average 401k participant savings rate in 2022 was 7.4%.
⚠️ Fact: Average 401(k) participants over 50 earning $100,000 annually in the 30% tax bracket are leaving approximately $6,800 on the table.
To keep the math simple, let's assume an average salary for these participants is $100,000 (the real average salary is considerably less). This means the average participant is contributing $7,400 to their retirement plan.
For context, the current maximum pre-tax employee 401(k) contribution allowed in 2023 is $22,500 plus a $7,500 catch-up if you're over 50. As you can see, there's a considerable disparity between the average, and maximum allowable 401(k) participant contribution.
If this hypothetical employee instead decided to maximize their 401k, was over the age of 50 and had a high effective tax rate of 30% (other spouse would have to be a big earner to be at that rate), those additional retirement contributions would result in a tax savings of approximately $6,800.
401k plans aren't the only retirement savings vehicle with significant contribution limits.
Here are three other company retirement plans you should pay attention to and consider maxing out for 2023 👇
SEP IRA - $66,000 max
Solo 401k - $66,000 plus $7,500 catch-up if over the age of 50
Simple IRA - $15,500 plus $3,500 catch-up if over the age of 50
👉 If you want to get the biggest tax benefit from your retirement savings, don't just pick an arbitrary percentage of your income to save each pay.
Be intentional with your retirement savings and if able, seek to contribute the maximum contribution each year, especially if you're in a high tax bracket.
2. Offset income and capital gains with losses
In addition to saving money in your company's retirement account, capital losses are another way investors can slash their tax bill.
Unfortunately, the IRS limits the amount of realized investment losses that can offset ordinary income to $3,000 per year.
So even if you're in the highest 37% tax bracket, a $3,000 realized capital loss would only save you a little over a thousand dollars in taxes. That teeters on being a low-value tax-savings tactic. 😔
What makes a high-value strategy for capital losses? It's what many investors miss: The fact that losses can offset 100% of realized investment gains, meaning massive tax savings depending on your investment holdings and how proactive you are with your investment strategy.
The easiest way to illustrate this is with an example:
Assume Gary Gains has a brokerage account with $173,000 invested in the Delaware Ivy Value fund. For 2023, this fund is expected to pass 29% in long-term capital gain distributions to shareholders, meaning Gary will be receiving a 1099 with approximately $50,000 in capital gains to report on his taxes.
Thankfully, 🙏 Gary understands the benefits of diversification and has $200,000 invested in a globally diversified portfolio of ETFs that he purchased for $250,000 18 months ago. In other words, Gary has an unrealized loss of $50,000.
If Gary does nothing with his investments, he'll pay 15% on his long-term capital gain distribution, or $7,500.
But instead, Gary decides to take a more proactive approach with his portfolio and tax-loss harvests the $50,000 of losses within his globally diversified ETFs. In doing so, Gary would eliminate the long-term capital gain distribution and save $7,500 in taxes. 👏
Using investment losses to offset ordinary income and capital gains can lead to more tax savings than you may think.
3. Take advantage of tax credits
A tax credit is a dollar-for-dollar reduction in your tax bill and far more valuable than a deduction.
So it's important to pay attention to any tax credits you may qualify for.
👉 Here are 5 tax credits to keep on your radar (income limits apply for each)
The first is the home energy tax credit which applies if you've made qualifying energy-efficient improvements to your home. The maximum tax credit allowable is $1,200.
The second is the Residential Clean Energy Credit which includes things like fuel cells, heat and geothermal pumps and home electric vehicle chargers in your home. The tax credits for these home improvements vary depending on the type of upgrade.
The third is the Federal Adoption Tax Credit which amounts to $15,950 per eligible child.
The electric vehicle or EV credit is for qualifying all-electric and plug-in hybrid car purchases. The maximum credit (depending on make and model) for 2023 is $7,500.
The American Opportunity Tax Credit is available for college tuition costs for students in their first four years of study. The maximum credit for 2023 is $2,500 for each qualifying student.
To put this all into perspective, a married couple with a tax liability of $27,000 who made enough energy efficient improvements in 2023 to max the allowable credit, adopted a child eligible for the adoption credit, purchased a 2023 Tesla Model 3, paid first year's tuition for their daughter to attend Penn State and stayed within the income limits for credit purposes would see their tax bill reduced to zero!
Now you may not qualify for all of these tax credits, but even if one or two apply, that could end up saving you thousands of dollars in taxes.
4. Bunch tax deductions
With the passing of the Tax Cuts and Jobs Act which imposed deduction limitations on state and local taxes in 2017, most folks who were accustomed to itemizing their taxes have since been forced to take the standard deduction which has doubled since 2017.
🥳 But behold, there is a workaround if you're willing to take some heat from your local taxing authorities!
True story: Back in 2017 when I heard about the changes coming to the tax code, I knew that my real estate taxes would no longer be deductible in 2018. So I took the liberty of prepaying my 2018 taxes in 2017 to get the most out of my tax dollars.
The only downside of this strategy was a nasty phone call I received from the county clerk's office telling me I shouldn't do this anymore as it's difficult for them to account for prepayments. I apologized, hung up the phone and later collected a generous 4-figure refund on my 1040.
Prepaying real estate taxes is one option for which investors can lump tax deductions in one year to optimize their tax savings.
✅ Another is charitable donations.
If you're used to donating a set amount to charities each year, you may decide to instead make a large donation all at once to what's called a Donor-Advised Fund.
A Donor-Advised Fund is an account setup to allow donors the ability to make charitable contributions to an investment account, receive an instant tax deduction and later determine when and where their dollars are to be donated.
Example: If Joe and Jane Smith typically donate $5,000 each year to various charities, they may not be able to deduct this amount on their taxes if their total itemized deductions are less than the standard deduction of $27,700 (SALT limited to $10,000 mind you). If, however the Smiths decided to lump 5 years' worth of donations into one (assuming they have the funds) and contribute $25,000 to a Donor-Advised Fund, they'll likely receive a hefty tax benefit come April 15th.
✅ Business owners can also benefit from being intentional with their purchases/expenses.
The Section 179 deduction allows businesses to expense the full purchase price of a fixed asset in the year it's placed in service. And with the current deduction limit sitting at $1,160,000 business owners stand to save a considerably amount of tax dollars simply by strategically reinvesting capital back into their business.
If you've read anything I've written over the past few years, you'll know I'm all about finding creative ways for investors to save money on taxes.
Granted, we all need to pay our fair share, but there's no rule mandating we give the IRS a tip.
However, carrying out a tax-savings strategy solely for tax purposes alone is not advisable.
If you're maxing out your 401(k) just to cut down your bill yet also want to put a down payment on a vacation home and only have a few thousand in your checking, does tying up your money in a retirement account make the most sense?
This next one I've seen many times and may not be the wisest decision: A business owner buys an expensive piece of equipment in December just to get a tax break instead of paying down debt and building working capital. Is this the best use of their cash?
Assessing your financial health and goals should always be considered first and foremost before carrying out any tax-savings strategy.
As I often tell clients, "Don't let the tax tail wag the dog."