Legit ways to pay less tax
Disclaimer – I’m neither an accountant nor a tax professional, so what follows is not tax advice. As the advertisers say, your results may vary. However, I am an experienced HR and payroll pro, and with the recent news about the President’s $750 tax bill, You won’t be surprised to know that I have thoughts.
In the recent New York Times article about the President’s tax returns, it was noted that he has used business losses to offset his business gains, thereby reducing his tax liability. That’s a common strategy, and it’s legitimate if it’s done correctly. Some accountants are more aggressive than others in their interpretation of what’s permissible. It appears the President’s accountants may have a more… generous interpretation of the Internal Revenue Code, but we cannot say for sure without examining the actual tax returns, and that’s way beyond the scope of this post.
It’s safe to say that most of us don’t have that type of income to manipulate. If you’ve arrived at my website because you need help with your resume, you are probably compensated via wages that are paid from a company’s payroll. And, as you surely know by now, there are many rules concerning the taxation of those wages.
So let’s talk about a few ways that most typical American wage earners can reduce their income tax liability.
One way to reduce your taxable wages is by deferring some of your compensation into your employer’s 401(k) or other retirement savings plan. You can choose to defer pre-tax, and you might also have the option to defer pay after-tax via a Roth feature. Roth deferrals don’t reduce your taxable income now, but it could be a tax advantage in the future when you withdraw the money. But with pretax deferrals, you can put away lots of money that you’ll need later, when you retire. This year, if you’re under 50 years old, you can save $19,000, and if you’re 50 or older, you can save up to $26,000. 401(k) deferrals are not federal or state income taxable (well, most states) (looking at you, Pennsylvania), but they are Social Security and Medicare taxable.
If you’re enrolled in your employer’s group health plan, they probably allow you to pay your share of the premiums with pre-tax dollars. You may hear this referred to as a Section 125 plan, which is the IRS code that allows pre-tax payment. Section 125 deferrals are not taxable for federal or state income tax, nor are they Social Security and Medicare taxable.
And don’t forget, you are probably not paying your full health premium; your employer likely pays a good chunk of it on your behalf. You most likely aren’t taxed on the premium they pay, either. (There are exceptions, and if they apply to you, you probably already know you’re subject to them. We’re talking to everyone else right now.)
Also under Section 125, you can defer your own compensation to pay for certain health care and/or dependent care expenses. If you have these expenses, you’ll pay for them anyway, so why not set aside money in a special account and pay less in taxes? I’ve heard employees say it’s not worth the bother; call me crazy, but if someone says I can *not* pay taxes on $5,000 and all I have to do is send in some receipts, that’s worth my time and the minimal effort required.
Pre-coronavirus, when most of us commuted to offices instead of working at home with bare feet, we could use pre-tax dollars to pay for our parking or our transit fare. That’s a less compelling feature if, like me, you are teleworking now, but if not, you can set aside $270 a month for transit *and* $270 a month for parking, as long as those expenses are necessary for your regular commute. That’s $3,240 a year, each.
Just for fun: Assume you are a single individual and you’re setting aside $5,000 in 401(k), $1,300 in health insurance premiums, $1,000 to your flex spending, and $3,200 in commuting expenses. That’s $10,500 of your salary that you’re excluding from income, which results in around a $3,000 reduction payroll tax withholding. If that’s a rounding error to you, congratulations. Let’s have coffee sometime (your treat). But for the rest of us, that could make the difference in which tax bracket you end up in when you file your 1040.
The amount you save depends, of course, on how much your salary is and how you’ve set your federal and state tax withholding from pay. And your ultimate tax liability – the amount you calculate on your 1040 – also depends on some other things, like whether you’re married, if you have other income, or whether you can itemize your deductions. But you get my point, right? You can save a lot of money by taking advantage of pre-tax savings programs offered by your employer. Why wouldn’t you? If none of this sounds familiar, please, do some research, check your employer’s self-service portal, or ask your friendly HR rep for information. And feel free to comment here or contact me if you have questions.
