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Chances are, maximizing your tax savings is top of mind this time of year—especially if you have multiple income streams. When dealing with income from various sources—a job, a business, investments, and more—tax time can get complicated. Fortunately, there are plenty of ways to maximize your tax savings. So read on to discover five tried-and-true best practices that every multi-income earner should know to minimize their tax burden.
Different tax rates can apply to different sources of income. For example, long-term capital gains—profits from the sale of assets such as stocks, bonds, mutual funds and real estate you’ve owned for more than a year—are generally taxed at a lower rate than ordinary income—wages from a job or profits from a business.
The federal income tax rate on long-term capital gains depends on your total taxable income, but it can be as low as 0% and as high as 28%. Meanwhile, tax rates on ordinary income and short-term capital gains range from 10% to 37%.
When you understand the tax rates that apply to different sources of income, you can plan accordingly and maximize your tax savings. For example, you can hold onto investments for more than a year to take advantage of lower long-term capital gains tax rates or harvest losses from poor investments to offset capital gains.
A tax-advantaged retirement account can be a great way to reduce your taxable income. Here’s a quick overview of some of the most widely used tax-advantaged retirement accounts:
You can also leverage tax-advantaged accounts to save for healthcare costs. For example, if you have a high deductible health plan (HDHP), you can contribute to a Health Savings Account (HSA). Contributions to the account are tax-deductible. You can withdraw the money tax-free if you use it to pay for qualified medical expenses, such as doctor visits, prescription drugs and vision care. Any unused funds roll over from year to year.
Flexible Spending Accounts (FSAs) are tax-advantaged accounts available through employers. Like an HSA, they allow you to set aside pre-tax money for medical expenses. Contributions to a flexible spending account are tax-deductible, and you can use the funds to pay for qualified medical expenses. However, unlike an HSA, FSAs have “use it or lose it” rules, meaning unused funds in the account don’t roll over from one year to the next.
Taking advantage of various tax-advantaged accounts can help you save money and reduce your total tax liability.
Choosing the right business structure can be a great way to maximize your tax savings. Depending on the type of business you are running, different types of structures may be beneficial for tax purposes. For example, if you run a sole proprietorship, partnership, or limited liability company (LLC), you won’t be liable for corporate taxes, but your profits are taxed as personal income. On the other hand, if you elect to have your LLC taxed as an S corporation, you may be able to reduce your self-employment taxes.
The right business structure depends on several factors, including the type of business you’re in and your overall tax situation. For that reason, it’s a good idea to discuss the decision with your tax professional. We can help you run the numbers to help you make the best decision for your circumstances.
The difference between active and passive income is a critical distinction that can have a big impact on your tax liability. Active income comes from employment, such as wages and salaries or profits from a business you actively participate in. Passive income comes from earnings from rental properties, royalties, and companies you don’t actively participate in.
Often, clients assume that losses from a rental property or passive business will offset other types of income, but that usually isn’t the case because of passive activity loss rules. Passive activity loss rules limit your ability to shelter salaries, wages, and other income with deductions from activities in which you don’t “materially participate.”
For example, say you’re a silent investor in a startup generating losses while the company gets off the ground. You can use those losses to offset income from other passive activities, such as a rental property, but not income from your consulting business that you’re actively involved in.
If you’re considering investing in a new venture or property, it’s a good idea to discuss it with your accountant to ensure you know how it will impact your federal income taxes.
Tax credits and deductions can be a great tool to reduce taxable income and maximize your tax savings.
Common federal tax deductions for individuals include the standard deduction, charitable donations, medical expenses, state and local taxes, and mortgage interest. If you own a business, you can deduct ordinary and necessary business expenses. These vary depending on your industry, but some common examples include costs of goods sold, salaries and wages, advertising expenses, rent, utilities, supplies, and the home office deduction.
While a tax deduction lowers your taxable income, tax credits are a dollar-for-dollar reduction in the amount of tax you owe. Some common examples of tax credits for business owners include the Research & Development Credit, the Work Opportunity Tax Credit, and the new Clean Vehicle Tax Credit.
To claim these deductions and credits, be sure to track all your deductible expenses throughout the year. Keeping accurate records of expenses can help you maximize tax savings when you file your return.
Multiple income streams can be a great way to build wealth and financial security. But it’s essential to do some tax planning to ensure you take full advantage of every potential tax deduction and other saving opportunities. If you need help lowering your taxable income, contact NewWay Accounting today. We’d love to work with you to create an optimal tax plan that helps you minimize your tax burden and save money.
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