If the thought of sending yet another immense payment to the IRS makes you cringe, it is time to take action. There are numerous steps you can take to reduce your income tax obligation. Check out some of your options so you can make the right move for your financial situation.
1. Increase Your Retirement Savings
One of the simplest and most financially prudent ways to decrease your income taxes is to increase your retirement savings. Multiple types of retirement accounts enable you to make pre-tax contributions; these contributions decrease your taxable income so that you pay less in taxes.
If you have a 401(k) plan, the IRS limits your annual contribution to $18,000 (as of the 2016 tax year). However, your plan may have a lower limit. If you are over 50 years of age, you can contribute an additional $6,000 each year.
A traditional IRA is a terrific alternative if you don't have a 401(k) plan or have maxed out your contributions for your 401(k) plan. Each year, you can contribute $5,500. You can make a catch up contribution of $1,000 per year if you are 50 or older.
However, the tax deduction for traditional IRA contributions eventually phases out. The exact amount that it phases out or ends completely depends on your filing status and taxable income.
2. Change How You Pay for Daycare
Daycare is a significant expense for many working families. By changing how you pay for daycare, you can make this expense a benefit for your income tax obligation.
If you have the option, use a dependent care flexible spending account (FSA) to set aside money to pay for your child's daycare. Single parents have the ability to contribute up to $2,500 a year, while married parents may contribute $5,000 a year. These contributions are pre-tax and decrease your taxable income.
Once you have paid for daycare, you can submit your proof of payment to receive reimbursement from the FSA.
3. Invest in Yourself
If you've always dreamed of furthering your education, now is the time to do so. Expenses for higher education realize a plethora of possible tax benefits.
Tuition and other qualifying expenses may qualify you for a tax credit or a deduction. Both decrease your ultimate income tax obligation. You need to run the numbers to determine which option keeps more money in your bank account.
You can even save for your education by contributing to a 529 plan. Though 529 plan contributions are not deductible on your federal taxes, you can deduct them to reduce your state income tax.
To learn more, contact a financial planning service.