Ten Ways to Save on Taxes

Contribute to your 401K or a Traditional IRA.  

You get two tax benefits with these accounts.  Your contributions are before tax with the 401K and tax deductible in an IRA if you are within the income limits (IRA Pub 590).  A pretax benefit and a deduction is basically the same thing except the first in done through your payroll and the other is taken on your tax return. The advantage is an individual in the 25% tax bracket contributing $100 would have an out of pocket contribution of $75.  The other $25 is being put up by Uncle Sam.

The interest or earnings is these accounts grow tax deferred which means you do not have to pay taxes until the money is withdrawn.  Generally there is a 10% penalty for withdrawals prior to age 59 ½. 

Flexible Spending Accounts

Take advantage of flexible spending accounts.  These accounts are set up by your employer and allow you to pay for things like health care expenses, and childcare cost with before tax dollars.  There are limits to how much you can put into these accounts and if you do not use the funds by a certain date you lose them.  

Commuter Benefits

Another employer benefit is commuter benefits.  This allows you to pay for parking and mass transit through payroll deduction with pre-tax dollars.  

Deductions. 

Many people miss deductions that they qualify for.  Certain deductions like the ones above and others: alimony, educator deduction for teachers who buy supplies out of pocket for their class room, moving expenses for job relocation and more.  

Tax Credits.

Tax credits reduce your taxes dollar for dollar.  The energy tax credit which expired 12/31/2007 is not available for your 2008 return but has been reinstated for 2009.  So if you buy new energy efficient exterior doors, windows, insulation, or a high efficiency heater or water heater you can qualify for as much as a $500 credit.  

Tax harvesting investments.

If you sell certain investments at a loss you can write off the losses against the gains plus an additional $3000 (Married filing jointly) against ordinary income. Read Get Rich Slowly's blog on the subject. 

 Hold on to your investment for more than one year because long term capital gains top out at 15% for investments held greater than 1 year.  

Tax Favored Investments

As mentioned above employers sponsored plans and IRA’s are a great way to save on taxes but so are other accounts like education savings accounts and 529 for tuition.  The Roth IRA is a great way to save taxes in the future. See post, "To Roth or not to Roth". 

If you are in a high tax bracket you may be better off investing in tax free municipal bonds versus corporate bonds.  They have lower yields but on a tax equivalent basis you may be better off. 

Charitable donations

Most people donate to charity because they want to help the cause, but if you itemize it is also a deduction on your tax return. You will need to make sure the charity qualifies as one under IRS guidelines. You also want to write a check or use a credit card so you have a record of your donation.  If you are donating clothing or other items, get a receipt. 

Start a family business.

A family business will allow you to pass income to your kids who should be in a lower tax bracket.  You may also take the home office deduction if you use part of your home to run the business.  Pay attention to the rules for the home office deduction because if you take it, you want to get it right.  It is rumored that tax payers taking the home office deduction are more likely to be audited.  That takes us to our last tax saving tip.

Stay organized and keep good records.

Many people lose track of medical expenses, auto miles, charitable donation and other deductions that they could take if they only had the records.  Start a file in January and start putting all tax records for the current year in it.  You can organize it right before tax time.  If you are one of those people that can stay organized then keep separate files for certain deductions (like health care expenses) and credits.  Once you have your records organized and your tax return completed, hold on to them.

You can find out all the details on the above tips at IRS.gov.