Contributed by: Matt Trujillo, CFP®
Every year, as the initial filing date approaches for federal tax returns, inevitably a client calls or emails with something along the lines of “Help! I owe the feds some money! Is there anything I can do to avoid the tax?!”
I can certainly empathize with getting hit with an unexpected tax bill, and depending on your situation sometimes there are perfectly legal ways to avoid an unexpected tax bill. I have summarized a list of ideas below to keep in mind in case you find yourself in this situation:
Max out the HSA
If you have a qualified high deductible health plan and have an account established, you can defer up to $6,650 in 2015 and this can be done up to the filing deadline of April 18th for 2016.
SEP IRA
For 1099 earners look at setting up and contributing to a SEP IRA; this can be as much as 25% of your net income after expenses that are accounted for on the 1099 income.
Spousal IRA contribution
Maybe you work and have access to a 401(k) or 403(b) plan so you’re not able to make a deductible IRA contribution, but don’t rule this out entirely as your spouse could potentially make a deductible IRA contribution even if they aren’t working. Up to $5,500 for those under 50 and $6,500 for those over 50.
All of the aforementioned can be done right up to the filing deadline of April 18th for 2016, so it makes sense to review these even if it's passed December 31st of the calendar year! If none of these apply to your situation and you are wondering how to avoid owing a big tax bill again on next year’s tax return, consider the following ideas to help mitigate the upcoming year’s tax liability:
Max out 401(k)’s
For those under 50, you can contribute $18,000 and for those over 50 you can contribute $24,000. This has to be done through payroll deduction so you only have until December 31st of the calendar year to defer money into the plan and avoid income tax.
Deferred Compensation Plan
Some plans will allow you to defer your entire salary if desired so make sure you explore the options in your plan and know the specifics of how it works. These plans can be subject to substantial risk of forfeiture, so be very careful and make sure your organization is on solid financial footing before contributing to these plans.
Increase withholding on your paycheck
Nothing fancy here. Sometimes it's just as simple as sending an email to human resources and letting them know you want to withhold more state and federal taxes from your paychecks so you don’t get hit with a big tax bill at the end of the year.
Be sure to consult with a tax professional before implementing any of these strategies.
Matthew Trujillo, CFP®, is a Certified Financial Planner™ at Center for Financial Planning, Inc. Matt currently assists Center planners and clients, and is a contributor to Money Centered.
Any opinions are those of Matt Trujillo and not necessarily those of Raymond James Financial Services.