It’s tax time again (collective groan). But it doesn’t necessarily have to be painful, especially if you can find some tax savings that result in a nice refund. Most people believe once December 31st passes there is nothing else that can be done to reduce the taxes owed for that year. Fortunately, that isn’t true. Here are three ways to reduce your taxes for 2016:
1) Make a Traditional IRA Contribution – You can make an IRA contribution up until April 18th, 2017 and have it count for 2016. To be perfectly clear, there are two types of IRAs – traditional IRAs and Roth IRAs. Traditional IRAs provide an upfront tax deduction but you will owe taxes on the money you take out in retirement. Roth IRAs don’t provide an upfront tax deduction, but the money you take out in retirement is tax-free.
The 2016 contribution limit is $5,500 and if you are over age 50 you can contribute an additional $1,000 for a total of $6,500. Make sure to check out these IRS guidelines for the deductibility limits if you have a high income. The rules differ depending on if your employer offers a retirement plan or not.
2) Make a Health Savings Account (HSA) Contribution – You can make an HSA contribution up until April 18th, 2017 for the 2016 tax year. If you had a High Deductible Health Plan (HDHP) that has a minimum annual deductible of $1,300 for single coverage or $2,600 for family coverage you are eligible to contribute to an HSA. The maximum contribution is $3,350 for single and $6,750 for family. If you are older than 55 you can contribute an additional $1,000.
Health savings accounts have a triple tax advantage in that you receive a tax deduction for the contribution, any interest or investment earnings are tax deferred, and, if you use the withdrawals for qualified medical expenses they are tax free. Also, if your employer plan is a Section 125 plan you may be able to avoid FICA taxes on contributions as well, saving another 7.65%! This type of account is as good as it gets from a tax perspective.
3) Open and fund a SEP IRA for your business – A SEP IRA can be set up and funded as late as the due date of your tax return, including extensions; so in theory you could make contributions to reduce your 2016 tax bill as late as October of 2017. You must own your own business and have documented profits to contribute to a SEP IRA. The inner details can be found here. This can be a great way for a small business owner to shield income from taxes and save for their retirement.
Steven Elwell, CFP®