Is There a Way to Minimize my Federal and State Income Tax Liability?

[nico08]

I am just trying to figure out if there is a way for me to minimize my federal and state income tax liability. I am not a homeowner, so no mortgage interest or property tax deduction for me. I contribute the maximum allowed amount to my 401k. I have the full amount going into a Roth IRA. I believe my income level makes me ineligible for a traditional IRA. I am not self-employed. I have my health insurance through work, and the premiums are paid with pretax income. The premiums are pretty low and the coverage is pretty good, so I don't think setting up a high deductible health insurance plan with a health savings account makes sense for me.

I am just wondering if there are any other ways to legitimately defer my federal and state income tax or otherwise minimize my tax liability.

I live in New Jersey, but due to my job, I could not relocate at this time even if there is another state that might have a lower state income tax.

My 2010 federal tax return, done with Turbo Tax, says my effective tax rate was 17.27%.

Thank you for your advice.

 

[Hamlet]

Well, most of the tax breaks in the current system go to homeowners and parents.

I wouldn't recommend changing your status in those regards for the tax breaks though

 

[Animorph]

Tax-loss harvesting (balance captial gains with losses if possible, with up to $3k extra losses you can subtract from income), tax efficient investing (index funds and tax managed funds), and holding the higher-income/capital gains funds, stocks, or bonds in your tax exempt accounts instead of you taxable accounts. All can help a little.

Long-term, plan to convert 401k/IRA amounts to Roth (with taxes paid from taxable accounts) whenever your income falls into the lowest tax bracket you expect to see in the future, up to the top of that tax bracket. In addition to reducing future taxes on withdrawals, that also reduces your RMD so that you may not be forced to withdraw more than you require from IRA's and unnecessarily raise your income. Typically this is possible when your early retire before SS kicks in.

 

[ERD50]

You could take the Timothy Geithner approach. Just don't claim some of your income, and if caught, pay back-taxes only up to the statute of limitations. No fines due, and last time I checked he was not in prison.

Everything to gain, and nothing to lose.

Timothy Geithner - Wikipedia, the free encyclopedia

-ERD50

 

[Bimmerbill]

Are you eligible for a flexible spending account or dependent spending account? That is all pre-tax dollars.

 

[nun]

If you have a 401k you probably don't also have access to other deferred retirement accounts, but some people in state government or non- profits might have a pension plan and also access to 403b and 457 plans. However, you can supplement a 401k with a tax deferred annuity. You use after tax dollars to buy this, but the gains are tax deferred and you pay income tax on them when you make withdrawals. So income tax rates are vital to whether this is a good option, but you would remove the gains and distributions from your current tax bill.

 

[samclem]

Could you become self-employed? Not full time, but if there's anything you (or your spouse) have going now that would work as a business, you can generate many deductions.


Bundling of itemized deductions? If your itemizable expenses (charitable giving, etc) now come close to the standard deduction amount each year ($5800 for single, $11,600 for MFJ in 2011), this can save you a lot. Take the standard deduction one year, lump all your itemizable expenses into the following year and itemize. Lather, rinse, repeat. It's a simple tactic, but many folks overlook it.

 

[Mulligan]

Does your state have a 529 plan for a state income tax deduction to save for future college expenses for you or your children if you have any? Contributing to mine helped me double this year. I received the 6% state income tax deduction from the contributed amount and will bring my state AGI under the max limit to claim an almost $2k state pension tax credit.

 

[nun]

Could you become self-employed?

That's a great idea as you can set up a SEP IRA or even a defined benefit plan. Both of these allow far larger contributions that regular IRAs

 

[samclem]

That's a great idea as you can set up a SEP IRA or even a defined benefit plan. Both of these allow far larger contributions that regular IRAs

Right, or a SOLO 401K. The first $16,500 can go right in there (Employee contribution), plus another 25% of whatever was earned (Employer contribution--computed on compensation after deducting the self-employment tax). Total max tax deferred contribution is $49K in 2011, slightly more if the individual is over 50. All of it comes right off the top of earned income, but taxes are due (at the regular income rate) on withdrawal.

 

[nico08]

Does your state have a 529 plan for a state income tax deduction to save for future college expenses for you or your children if you have any? Contributing to mine helped me double this year. I received the 6% state income tax deduction from the contributed amount and will bring my state AGI under the max limit to claim an almost $2k state pension tax credit.

I will check to see if New Jersey has a 529 plan. Do you happen to know what happens to the 529 money in the event that it is not used for future college expenses?

 

[Mulligan]

I will check to see if New Jersey has a 529 plan. Do you happen to know what happens to the 529 money in the event that it is not used for future college expenses?

I believe but am not certain, you have to pay the tax on the amount withdrawn, plus a 10% penalty. So you would definitely need plans to pay for schooling for yourself or family member before setting one up. I also believe you can always change the name of the person it is set up for at any time. The accumulated investment money if used correctly can be withdrawn tax free, also. Different states have different contribution limits. Btw- I just briefly checked and it appears New Jersey does not offer the initial tax deduction for a 529. Ouch, no wonder people call it tax hell up there. This might not do what you are looking to do.

 

[Finance Dave]

Many good ideas already posted....here's more:

1) You don't say if you're married, but does your spouse have tax-deferred plans? I have friends who had both spouses with 401ks, the man earned a ton of money, and the wife very little....for some reason they had this goofy idea that she could not afford to fund her 401k (she makes about $30k/year), so she only had 5% ($1,500) withheld. I suggested she fully fund it and they need to start thinking like a family rather than two different people.

2) Is most of your income active or passive? The reason I ask is that you can open an LLC and generate losses, and write off passive gains from your personal return through the LLC losses (if you set it up right, see your tax advisor). You might say "but wait, I don't want to open a business just to lose money!". Right, but in my case I'm losing money NOW by pouring loads of repairs into the properties, and then when I rehire in a few years and my income is much lower, these properties will return profits....so it's a timing thing.

3) Do you get any benefits such as salary deferrals or stock options? If so, there may be some opportunities in that regard.

Good luck

 

[pb4uski]

I would suggest that you take another look at a HSA. What I do is to pay for my medical expenses with taxable funds and make the maximum contributions to my HSA. It has the effect of increasing my tax deferred savings similar to my 401k.