Knowing how to manage your finances so they are not taxed more than necessary is an important skill.
Sheri Moore is a tax preparer based in Douds, in Van Buren County. She said there are a number of ways a person can legally reduce their tax liability. Some employers will offer employees the option of putting money aside in special nontaxable accounts. Money put in these accounts does not count toward a person’s income when they pay income taxes every year.
A couple common accounts of this type are flexible spending accounts and health savings account. A flexible spending account is one used to pay medical expenses such as prescriptions, co-pays or anything that a person’s health insurance does not cover. A health saving account is similar except that it is done in conjunction with a high deductibility health insurance plan. Moore said another difference is that flexible spending accounts are usually “use it or lose it,” meaning the money put in them must be spent on medical expenses or it’s lost, whereas money in health savings accounts can accrue from one year to the next.
Another way to limit tax liability is by putting money into a retirement account, either through a 401(k) with your employer or an individual retirement account on your own. Money put in these accounts is not taxed when it is put in, but it is taxed when it is taken out. They are tax deferred, not tax exempt.
That might make it sound like it wouldn’t affect a person’s tax liability, but Moore said it can. That’s because when a person is drawing from their retirement account, they are probably reporting less total income than when they were earning it, and that would put them in a lower income tax bracket.
Some employers match their employees’ 401(k) contributions, or match a portion of it. Moore said a number of people still don’t put money into a 401(k) account.
“Some employers match 2 percent or more, and if you aren’t taking advantage of that match, you’re missing out on free money,” she said.
Getting married and having children can affect a person’s tax liability, too. Moore said the conventional wisdom used to say that it was better for a couple to file jointly, but that’s not necessarily true anymore since for some people it would make sense to file separately.
“Sometimes couples lose out on deductions because [their combined income] puts them into a higher income tax bracket,” Moore said.
Adults can receive a tax deduction for each child they have, which is $2,000 for each child under 18 years of age. Moore said parents can still receive a deduction for adult children they claim as dependents, but they don’t get as much of a tax break, only $500 per dependent.
Moore said donating money once garnered a nice tax break, but that’s not true anymore, she said.
“It’s not going to help my taxes that much if I give someone a large amount of money,” Moore said.