3 ways to legally reduce your taxes in 2016
Austin Smith, for Motley Fool 9:17 a.m. EDT June 9, 2016
If you’re smart about tax planning, you could save hundreds, or even thousands of dollars on your 2016 taxes.(Photo: 401KCALCULATOR.ORG VIA FLICKR.)
Tax planning isn't just something you should do in the month or so before you file your tax return each year. Rather, smart tax planning should be a year-round effort, and the benefits can be huge. With that in mind, here are three suggestions from our writers that could help you reduce your 2016 taxes and keep more money in your pocket.
Selena Maranjian[1]: One way to legally reduce your taxes in 2016 is to harvest some losses. You probably know you face capital gains taxes on assets you sell for a profit. The tax rate is 15% for most of us when the assets sold were held for more than a year. Short-term capital gains, from assets held a year or less, are taxed at your ordinary income tax rate, which is 25% or 28% for most of us, but can approach 40% if you're a high earner.
If you happen to be sitting on some capital losses, such as stocks that have lost value since you bought them, you can put those losses to good use, offsetting some or all of your gains. For example, if you have $10,000 in long-term capital gains and $4,000 in capital losses, you can offset the gains with the losses and only face taxation on $6,000 in gains.
It even works if you have no gains, or smaller gains than losses. Imagine, for example, that your gains total $5,000 but you have $10,000 in losses. You can wipe out all of the gains with $5,000 of your losses -- and you can also offset up to $3,000 in taxable income with losses. That makes good use of $8,000 of your losses. What about the remaining $2,000? Well, even that isn't wasted: You can carry it forward to the next tax year, where it can offset more gains or income.
If you're not keen to sell any stocks to capture losses, know that you can always buy them back, at their now-lower prices -- as long as you wait more than 30 days before doing so. Buy them back sooner, and it's considered a "wash" sale, and that will foil your tax-saving plans.
Dan Caplinger[2]: One tax break many workers don't even know they have available to them is the ability to set up a flexible spending account at work. FSAs let you set aside money for healthcare or child and dependent care expenses on a pre-tax basis, with the intent of using that money over the course of the year. When you take money out of the FSA for those allowed purposes, you don't incur any tax. The net result is that what you spend on healthcare or child and dependent care escapes taxation entirely, lowering your eventual tax bill. FSA contributions are also exempt from payroll taxes for Social Security and Medicare, further boosting your take-home pay.
The most important thing to remember about FSAs is that if you put money into an FSA and don't use it, you can lose it. Until recently, any unused funds were automatically forfeited, but now, the IRS has provisions under which employers can allow up to $500 to be carried forward to the following year. However, this provision only applies if employers choose to allow it, so be sure to check with your HR department for details. Otherwise, you'll typically have until the end of the year plus a potential grace period at the beginning of the following year to spend down your FSA.
Matt Frankel[3]: If you've been on the fence about buying a home, be sure to consider the tax benefits you'd get.
The biggest benefit is the deduction for mortgage interest payments. The IRS allows you to deduct interest you pay on a mortgage loan secured by a main or second home, up to total mortgage balances of $1 million. When you buy a home, a large portion of your early mortgage payments will go toward interest, making this a potentially valuable tax deduction in your first few years of homeownership. You can even take this deduction on a second mortgage or home equity line of credit.
If you don't put at least 20% down, you'll also have to pay for mortgage insurance, which is tax-deductible, subject to income limitations. The deduction was set to expire at the end of 2014, but it was recently extended through at least 2016.
Property taxes are also deductible, as are various home improvements related to energy efficiency. If you pay points on your mortgage, they are also a tax deduction.
Keep in mind that you'll need to itemize deductions in order to take advantage of homeownership-related tax deductions, but these could easily add up to five-figure deductions each year depending on your particular home and mortgage, and that can be a big incentive to finally take the plunge and buy.
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References
- ^ Selena Maranjian (my.fool.com)
- ^ Dan Caplinger (my.fool.com)
- ^ Matt Frankel (my.fool.com)
- ^ Simply click here (fool.com)
- ^ The Motley Fool. (www.fool.com)