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How to Minimize Your Tax Liability: Best Practices and Strategies

How to Minimize Your Tax Liability: Best Practices and Strategies

November 14, 2023

Nobody loves the idea of parting with their hard-earned money for taxes at the end of the year. The good news is that you may not owe as much – if you take advantage of all the deductions and tax credits that are available to you. Learning how to minimize your tax liability could be easier than you thought, but it requires diligent planning throughout the year.  

Here is what you need to know about best practices and strategies that minimize your tax liability at the end of the year. 

Take Advantage of All Deductions and Credits

The first thing you need to do is understand all of the deductions and credits available to you. You might be surprised to learn that some of the investments you make already can reduce your tax bill. For example, mortgage interest on your home is a tax deduction, as is student loan interest. Some people even find that they can deduct medical or educational expenses. 

Consider some of these deductions to help you make the most of your money:

Contributions to Retirement Accounts

In many cases, contributions to a retirement account like a 401(k) or an IRA reduce overall taxable income. In a traditional retirement account, your contributions are tax-deductible in the year that you make them (as opposed to Roth accounts). 

While you will have to pay taxes on the money when you withdraw it in retirement, it can be a great way to reduce gross income for the year. Consider maxing out your retirement savings contributions whenever possible. 

Charitable Contributions

 Donating to qualified non-profits not only supports good causes but can also offer a tax deduction at the end of the year. Charitable giving can take many forms, but consider helping out a cause that is near and dear to your heart – and take the financial benefit in the form of lower taxes. 

One way to contribute to charity is to donate appreciated stock. This helps you minimize capital gains tax, which can really eat into your profit. Instead, a charity can put it to good use. 

Another way to donate to charity is through establishing a charitable remainder trust (CRT). This type of trust allows you to provide income to a beneficiary as well as a sizable donation to a charity of your choice. Charitable remainder trusts benefit from many tax advantages, and income taxes are only paid when the payments are parceled out. 

Real Estate

Did you know that owning a home provides numerous tax deductions? For example, you can deduct your mortgage interest and property taxes from your taxable income each year. Another way to maximize real estate for your portfolio is to consider investments that allow you to take advantage of depreciation and other tax benefits. 

Leverage Tax-Advantaged Accounts

If you qualify, you may consider maxing out accounts like a Health Savings Account (HSA) or a Flexible Spending Account (FSA). These tax-advantaged accounts allow you to set aside money on a pre-tax basis that can be used for qualified medical expenses.

Manage Your Capital Gains

It might sound counterintuitive, but you may be better off to hold onto your investments. If you have an asset that has appreciated in value, you may face steep capital gains tax penalties. Holding on to them for at least a year could allow you to qualify for the lower long-term capital gains rate. 

On the other hand, you might employ a strategy known as tax loss harvesting. This allows you to offset capital gains by selling off underperforming investments, helping you to realize a capital loss that costs you less on your taxes at the end of the year.

You can also sell real estate and other high value assets within a CRT to avoid some of these capital gains taxes.

Gift Assets

Another core strategy to reduce tax liability is to gift assets to family members or loved ones, up to the annual exclusion amount. This works because it reduces the overall size of your taxable estate, minimizing your out-of-pocket tax liability at the end of the year. Plus, it is a great way to be generous with your assets and wealth while keeping it within your family.  Remember that the cost basis usually carries over to the recipient. 

Tax-Efficient Investing

If you are interested in investing, you might want to consider investing in tax-managed or index funds. These reduce the number of taxable events in your portfolio which can yield huge savings for you at the end of the year. We recommend working with an investment advisor who can help direct you on the best path toward your goals.

Implement a Tax-Deferred Strategy 

If you qualify, you might want to consider whether you can minimize your tax liability right now by deferring it into the future. This includes strategies such as 1031 exchanges for real estate, tax-deferred accounts, and other deferral mechanisms you can take advantage of in this area. Some employers may offer deferred compensation plans as well, which can be used to defer income in a high tax year and receive it in a lower tax year.

If you think you will be in a better position to pay those taxes in the future, this is worth investigating. 

Keep Good Records

Ensure that you maintain documentation for all deductions, credits, and income sources you can claim each year. This can help you claim every possible benefit with your tax professional, but it also plays a crucial role in defending your claims if you get audited. 

You will want to have the law on your side if the IRS comes knocking, so do yourself a favor and keep detailed records. 

Seek Professional Help

There is no doubt about it: the tax code is complicated. A knowledgeable tax professional can provide insights tailored to your situation, ensuring that you never miss out on any opportunities. Plus, these tax laws change regularly. A professional will help you stay informed so that you and your portfolio leverage the latest applicable benefits. 

Magellan offers comprehensive estate, financial, and tax planning. We can help you set up a charitable remainder trust in a one-stop-shop that is affordable and comprehensive. Reach out to us today to learn more about how we can help you maximize your estate. 

For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.