Tax Planning

Tax Reduction Strategies

Income tax planning is a fundamental part of financial planning. The less money you pay for income taxes, the more money you have working toward achieving other financial goals. Below is an overview of many of the techniques currently available that can be used to minimize your current and future taxes.

Deferring Income

Deferring income means reducing your current taxes by postponing the taxability of income until a future year. One easy way to defer income is by maximizing contributions to company retirement savings plans, such as a 401(k) plan, as well as by using other tax-advantaged savings vehicles, including IRAs, annuities, and cash value life insurance. Some contributions to retirement savings plans can be made on a pre-tax basis where you defer income tax on the monies going into the plan. In this case, your contributions won't be taxed until you make withdrawals in the future. The income you earn on these accounts accumulates tax-deferred, which means the earnings on your money are not taxed until you make a withdrawal. Roth IRAs present the opportunity to receive distributions tax-free.

Maximizing Itemized Deductions

Individuals should itemize deductions if their total itemized deductions exceed the federal standard deduction which has been increased in 2020 from $12,200 to $12,400 for single filers and from $24,400 to $24,800 for married couples filing jointly. Deductions reduce the amount of your income that is subject to tax. The following are categories of itemized deductions:

  • Medical and dental expenses: This category should include the amount of unreimbursed medical and dental expenses (including prescriptions) not paid by insurance or reimbursed through a flexible spending account. Medical and dental expenses are deductible to the extent they exceed 10% of your adjusted gross income. You can also include transportation costs when traveling for medical purposes, including mileage at 20 cents per mile in 2020 (20 cents in 2019), tolls, and the cost of public transportation.
  • State and local taxes: The amount of state and local income taxes you paid in the current year may be deducted on your federal income tax return up to a limit of $10,000 in 2020(same as in 2019). This includes amounts withheld, estimated payments made in the current year, and any balance due on your prior year's state income tax return paid in the current year. Other deductible taxes include real estate taxes and certain personal property taxes.
  • Interest expense: Deductible interest includes home mortgage interest, investment interest, qualified student loan interest, and trade or business interest. Certain restrictions apply.
  • Charitable contributions: You may deduct contributions and gifts to qualified charities. Contributions may be in cash, property, or out-of pocket expenses (including mileage at 14 cents per mile in 2020 same in 2019) for volunteer work for qualified charities. No deduction is allowed for single contributions of $250 or more to any one organization unless you have a written receipt from the organization.
  • Miscellaneous deduction expenses: Cost of safe deposit box, etc. are deductible to the extent they exceed 2% of your adjusted gross income.

Casualty and theft losses: Nonbusiness casualty losses not covered by insurance are deductible to the extent they exceed 10% of your adjusted gross income. People can only claim casualty losses if they have been affected by an official national disaster. Business casualty and theft losses are fully deductible with certain limits applied.

Flexible Spending Accounts

Many companies provide employees with a variety of benefits such as medical and dental insurance, life insurance, long-term disability, and other health and welfare benefits. To obtain these benefits, employees usually have to pay some portion of the premiums. Flexible spending accounts allow you to pay for certain eligible benefits, such as health insurance, and pay for certain eligible expenses, such as unreimbursed medical expenses and daycare expenses, with pre-tax dollars. If you pay the premiums on a pre-tax basis, your cost is reduced since the money you pay is not subject to federal income tax or Social Security tax. At the end of the year, any unused balances are forfeited.

Health Savings Accounts

IMPORTANT NOTE: The Health Savings Account (HSA) permits eligible individuals who are not enrolled in Medicare to save for "qualified" medical health expenses on a tax-free basis. Note that over-the-counter (OTC) drugs unless prescribed are not a qualifying expense. These accounts may be offered through employers. However, any insurance company or bank can offer HSAs to eligible individuals as well.

For 2020, the IRS defines a high deductible health plan as any plan with a deductible of at least $1,400 for an individual or $2,800 for a family. An HDHP’s total yearly out-of-pocket expenses (including deductibles, copayments, and coinsurance) can’t be more than $6,900 for an individual or $13,800 for a family. (This limit doesn't apply to out-of-network services.). The annual “catch-up” contribution amount for individuals age 55 or older will remain $1,000

However, when used as intended, HSAs can grow tax-free, and unused balances can roll over from year to year. These accounts are also portable, and may be used across different jobs. These are all potential advantages of using the Health Savings Account when compared with the Flexible Spending Account.

There are additional details and restrictions that must be considered. Check with your financial professional or account sponsor regarding your eligibility to use the HSA. For more information, see the section Health Savings Accounts.

Tax Credits

Tax credits, unlike deductions, reduce tax liability dollar for dollar by the amount of the available credit. There are various tax credits benefiting many different types of taxpayers, including families with young children, the elderly, the disabled, and those with students attending college. Some examples are shown below. Consult your tax professional to determine which credits may be available to you.

  • Child and dependent care credit: A credit is allowed for a portion of qualified child or dependent care expenses that are paid in order for the taxpayer to work. The maximum amount of child care expenses that can be considered is $3,000 for one child or dependent, or $6,000 for two or more. The credit ranges from 20% to 35% of eligible child care expenses.  Taxpayers may claim a $500 temporary credit for non-child dependents.  This can apply to a number of people adults support, such as children over age 17, elderly parents or adult children with a disability.
  • Earned income credit: 

    The Earned Income Tax Credit (EIC or EITC) is a refundable tax credit for low- and moderate-income workers. The amount depends on income and number of children. People without kids can qualify. For 2020, the earned income credit ranges from $538 to $6,660.

    Here are some quick facts about the Earned Income Tax Credit (EITC or EIC):
    • For the 2020 tax year, the earned income credit ranges from $538 to $6,660 depending on your filing status and how many children you have.
    • You don't have to have a child in order to claim the earned income credit.
    • The earned income tax credit doesn't just cut the amount of tax you owe — the EIC could also score you a refund, and in some cases a refund that's more than what you actually paid in taxes.

 2020 Earned Income Tax Credit
 (for taxes due in April 2021)                  

Number of children Maximum earned income tax credit Max earnings, single or head of household filers Max earnings, joint filers
0 $538 $15,820 $21,710
1 $3,584 $41,756 $47,646
2 $5,920 $47,440 $53,330
3 or more $6,660 $50,954 $56,844


2019 Earned Income Tax Credit

Number of children Maximum earned income tax credit Max earnings, single or head of household filers Max earnings, joint filers
0 $529 $15,570 $21,370
1 $3,526 $41,094 $46,884
2 $5,828 $46,703 $52,493
3 or more $6,557 $50,162 $55,952


Both your earned income and your adjusted gross income each have to be below the levels in the table. In general, the less you earn, the larger the earned income credit.

Your earned income usually includes job wages, salary, tips and other taxable pay you get from your employer. Your adjusted gross income is your earned income minus certain deductions.

 Saver's Credit: 

The federal government created the Saver’s Credit (originally the Retirement Savings Contributions Credit) in the early 2000s. It’s already possible to deduct contributions that you make to a traditional IRA, but this credit provides even greater incentive. In particular, it is designed to help low- and moderate-income individuals save for retirement.

You’re eligible for the saver’s credit if you are 18 or older, not a full-time student and not claimed as a dependent on another person’s tax return.

You must also make a retirement plan or IRA account contribution, and fall under maximum adjusted gross income caps the IRS sets each year.

If your adjusted gross income is above any of these thresholds in 2019, you aren’t eligible for the saver’s credit:
• $64,000 as a married joint filer
• $48,000 as a head of household filer
• $32,000 as any other filing status

The income thresholds for the credit change each year to keep pace with inflation. You can find the income limits for the current tax year in the table below.

Credit Amount Single Head of Household Joint Filers
50% of contribution AGI of $19,500 or less AGI of $29,250 or less AGI of $39,000 or less
20% of contribution $19,501 – $21,250 $29,251 – $31,875 $39,001 – $42,500
10% of contribution $21,251 – $32,500 $31,876 – $48,750 $42,501 – $65,000
0% of contribution more than $32,500 more than $48,750 more than $65,000


Calculating the value of the saver’s credit
Unlike many IRS rules, the math here is fairly simple: The credit is worth 50%, 20% or 10% of a maximum contribution of $2,000 (or a total of $4,000 if you’re married filing jointly).

Let’s say you earn $19,000 as a single filer, and you contribute $1,000 to an eligible account. The value of your saver’s credit would be $500. If you managed to contribute $5,000 to an eligible account, your credit would be worth $1,000, due to the cap.

If your contribution was made to a traditional IRA, 401(k) or other account that offers a tax deduction for contributions, your taxable income would also be reduced by the amount of your contribution

Education Tax Incentives

If you paid for education expenses in the last year, you may be able to save money on your taxes by claiming the American Opportunity Tax Credit (AOTC) or Lifetime Learning Credit (LLC). The American opportunity credit is generally the most valuable, if you qualify.

You can claim these education tax credits and deductions even if you paid with a student loan. Parents can take advantage, too, so long as they don't choose a married filing separately status. Here's what to know about each option.

American Opportunity Tax Credit (AOTC)

The American Opportunity Tax Credit (AOTC) allows taxpayers to save money on their taxes if they paid higher education expenses for themselves, a spouse, or a dependent. The credit is worth up to $2,500 per student but only for their first four years of higher education. If you paid education expenses for multiple people, such as for two dependents, you can deduct up to $2,500 for each person. Your exact credit amount is calculated as the 100% of your first $2,000 of qualified expenses, and then 25% of your next $2,000 of eligible expenses. You need to have at least $4,000 of expenses per person in order to qualify for the maximum credit.

Qualifying expenses include tuition, fees you are required to pay in order to enroll in a course or program, books and classroom supplies and equipment.

Only a student’s first four years of higher education are eligible for the AOTC. This is typically just enough for an undergraduate degree and so graduate students don’t qualify unless their undergraduate degree took fewer than four years to complete. You don’t need to complete all four years consecutively, but a taxpayer can only claim the credit on four separate income tax returns. (The four-year limit includes any years you claimed the Hope credit, a previous version of the AOTC)

2020 AOTC income limits

Single $80,000 $90,000
Head of household $80,000 $90,000
Married, filing jointly $160,000 $180,000
Married, filing separately $80,000 $90,000
Qualified widow(er) $80,000 $90,000

Lifetime Learning Credit (LLC)

The lifetime learning credit, or LLC, is a tax break for taxpayers with education expenses during the year. This mostly covers tuition but includes other fees and costs you have to pay in order to enroll in a class or program, as long as you pay those costs directly to the school or program administrator.

Unlike other education tax credits, the LLC covers the cost of classes that help you to improve your job skills or learn new job skills. You do not need to be in a degree program to claim the LLC. However, most accredited postsecondary institutions do qualify.  The lifetime learning credit also covers your expenses for career development classes and other classes to learn or improve your job skills.

The lifetime learning credit is worth a maximum of $2,000 per tax return but you need to have at least $10,000 of expenses to be eligible for the full deduction ($20,000 if you file a joint tax return). You also need to fall within the income limits to claim this credit. For 2020, your income must be $69,000 or less ($138,000 for joint filers) to claim even a partial credit, up from $68,000 ($136,000 for joint filers) in 2019.

Qualifying expenses include tuition and fees you are required to pay in order to enroll in a course or program.

Your exact credit is calculated as 20% of your first $10,000 of qualified education expenses, which means you need to spend at least $10,000 ($20,000 for joint filers) on eligible expenses in order to get the full LLC.

The lifetime learning credit is not a refundable tax credit. So if the credit brings the amount of tax you owe for the year below $0, you will not get a refund for the excess credit. For example, if you owe $1,000 of income tax for the year and then you qualify for a $1,500 credit, you simply owe nothing and will not get a refund for the extra $500.

Tax-Exempt Investing

In constructing the income-generating portion of your portfolio, investing in tax-exempt vehicles (such as municipal bonds) can be used as a tax-saving strategy. When evaluating investments, you should compare the after-tax yields you are earning. You must look at a taxable investment on an after-tax basis in order to compare it with a tax-exempt obligation. You may also need to factor in state taxes when making your investment decisions.

If you decide to utilize tax-exempt investments, keep the following points in mind:

  1. Due to lower yields, you generally have to be in one of the higher marginal federal income tax brackets for municipals to make sense.
  2. Don't invest in tax-exempt municipals within a tax-deferred retirement plan. The money in your retirement account is already tax-advantaged.
  3. Occasionally, municipal funds declare a capital gain, which will be taxable.

Business Owner Tax Considerations

Self-employed individuals may establish tax-advantaged retirement plans with contributions based on net earnings from self-employment. Tax-advantaged plans include Keogh plans, Simplified Employee Pensions (SEPs), and Savings Incentive Match Plan for Employees—SIMPLE Plans. See your tax professional for information on retirement plans and other tax-savings retirement vehicles.

Self-employed individuals are currently entitled to deduct up to 100% of the amount paid for health insurance coverage for themselves, their spouses, and dependents during the tax year if they choose to itemize deductions. The deduction is limited to the net earnings from the trade or business for which the insurance coverage was established, minus the deduction for one-half of the self-employment tax and any Keogh, SIMPLE, and SEP deductions.

IMPORTANT NOTE: You cannot take a self-employed health insurance deduction for any month or part of a month that you were eligible to participate in an employer-sponsored health plan.

Other tax issues to keep in mind for a self-employed individual include:

  • If your net earnings from self-employment exceed $400, you will be liable for self-employment taxes. If you make estimated income tax payments, be sure to consider the self-employment tax.*
  • If you have employees, you must obtain a separate federal tax identification number and fulfill employment tax responsibilities.
  • A deduction may be available for certain expenses incurred in maintaining a portion of your home as an office. You must meet certain restrictive tests for your home office to qualify for deductions.

*The self-employed tax is a special tax filing for self-employed individuals. These individuals must submit their taxes using the form 1040 Schedule through the IRS.
In a traditional employee relationship with a W2, the burden of paying Social Security and Medicare falls upon the employer. Since you are self-employed, you pay as both employee and employer.

For 2020, the tax rate is 15.3% (same in 2019 ) on the first $137,700 ($132,900 in 2019) of combined wages, tips, and net earnings, and 2.9% on earnings above this limit.

Since you’re paying both portions (for employer and employee) of Social Security and Medicare, the rate breaks down as follows:
• The employee’s portion of the Social Security tax, which is 6.2% of the first $137,700 of net income
• The employer’s portion of the Social Security tax, which is 6.2% of the first $137,700 of net income
• The employee’s portion of the Medicare tax, which is 1.45% of all net income (no cap or limit on net income)
• The employer’s portion of the Medicare tax, which is 1.45% of all net income (no cap or limit on net income)

 Consult your tax professional for tax issues relating to self-employed business owners.

Withholding and Estimated Taxes

Paying too much or too little in taxes during the year can make budgeting difficult. If you received a large tax refund last year, this money could have been invested instead, helping you achieve your financial goals during the year. Project how much tax you expect to owe and be sure to have at least 90% of that amount withheld during the year. Another option is to consider using one of the safe harbor methods of making estimated federal income tax payments. You should consult with a financial professional to determine which tax payment methods are most advantageous to you, and to consider any state requirements that may apply.

IMPORTANT NOTE: Overpayments of tax are basically interest-free loans to the government.

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