The new tax laws brought along a few surprises for some taxpayers in 2018. As a result, you may be looking for new ways to lower your tax bill this coming year. Although the 2018 tax season is still underway, this is the best time to appropriately plan your tax strategy for 2019. Getting an early start will make the 2019 tax season easier, and it will help you take full advantage of opportunities to save money throughout the year.
Below are just a few ideas on how you can lower your tax bill for 2019. The best way to determine what will work for you is to talk to a financial advisor as soon as possible this year.
1. Consider Investing in Municipal Bonds
Many investment opportunities are not built on tax advantages. While having some investment losses can be beneficial to some taxpayers, growing your wealth most often has tax implications. Municipal bonds, however, have some important advantages that may motivate you to consider them not only as an income stream and long-term investment but also for tax planning purposes.
What is a Municipal Bond?
A municipal bond is issued by a government entity, most often a state, municipality, or county. They can only be granted by nonprofit organizations, private-sector corporations, or public entities. These bonds are used to finance necessary expenses for things like schools, roads, and government-run services.
There are two main types of municipal bonds. These include:
General obligation bonds. These bonds are backed by property taxes or payable from general There is no specific project (like a toll road or other revenue source).
Revenue bond. These bonds are connected to a specific revenue source, such as hotel occupancy taxes or sales taxes. In some situations, a third-party will make the payments associated with these bonds instead of the government entity paying them directly.
The type of bond that you have will have an effect on the return that you receive.
Returns on Municipal Bonds
Compared to private, corporate bonds, municipal bonds’ default risk is extremely low. There is some risk, however. Depending on the type of bond involved, consumer taxes and an economic downturn can have a significant impact on the return on a municipal bond. This is particularly true for bonds that are connected to a specific revenue source. Bond rates are also opposite interest rates—when rates go down, bond prices rise, and vice versa.
The return on this type of investment is lower because of the significantly decreased risk. They are often long-term investments as well.
Municipal Bonds and Taxes
Traditional corporate bonds are taxed at your ordinary income levels. Municipal bonds, on the other hand, receive special tax treatment that makes them an attractive option for investors who also want to save money at tax time.
Interest from municipal bonds is automatically completely tax exempt from federal taxes. If you buy a municipal bond within your state or local area, you may be able to avoid taxes from these entities as well. That means that interest you receive automatically goes into your pocket instead of having to share with Uncle Sam. There are exceptions to this from time to time.
You should keep in mind, however, that while your interest is tax-free, any gains that you receive from the bond will be taxed. Many municipal bonds are set up to be long-term investments, which means that you may be taxed based on a more favorable long-term capital gain rate. This rate is typically much less than your ordinary income tax rate.
There may also be other tax considerations for this type of investment as well. Your financial planner will be able to walk you through items you may need to consider for your unique situation.
2. Contributing to Retirement Accounts
You may have heard that contributing to your retirement account will help you save taxes, but many people do not make the right type of contribution to take advantage of this potential tax savings. Doing this correcting is a great way to not only save on taxes but also set you up well in the future.
Traditional IRAs and 401(k)s
You can take tax deductions for any contribution to a 401(k) or IRA, unless they are considered Roth accounts. Contributing to an IRA or 401(k) lowers your taxable income overall, which means that your tax burden will be decreased. It is a benefit that does not rely on itemization, which is nice for those who do not normally itemize on their tax returns.
These deductions are limited, however. You can contribute up to $19,000 to a 401(k) and another $6,000 to an IRA for 2019. If you are over 50 years old, you can also include “catch up” contributions of up to $6,000 to a 401(k) and another $1,000 to an IRA. However, you will be taxed on withdrawals from your 401(k) and IRA—this investment option is tax-deferred, not tax exempt.
Roth IRAs, on the other hand, provide tax benefits later, when you withdraw the funds. Roth IRAs work well for those who may be in a higher tax bracket as they retire. Earnings and withdrawals, as long as they comply with the “rules” of Roth IRAs, (such as waiting to take withdrawals until you qualify) are tax-free.
You should keep in mind, however, that the tax benefits of contributing to a retirement account may phase out for higher income levels.
3. Sell Off Losing Investments
Although you may not want to sell investments that are currently at a loss, that process can have tax advantages as well. Investment instruments, including stocks, are only taxed when you “realize” the gain or loss, which is generally when you sell the stock. You will also be taxed on interest or other periodic payments as ordinary income as well. However, you can use the losses associated with a particular investment to offset any of your other capital gains from other sales.
These losses are treated differently depending on whether they are considered long-term or short-term losses. Long-term losses occur when you held the asset for more than one year. Otherwise, they are considered short-term losses, even if you kept the investment for 364 days.
Short term losses and long-term losses will offset one another separately in each category. That is, short-term losses offset short term gains, and long-term losses offset long-term gains. However, you may not have enough losses offset gains in each category. If this is the case, then you can use your short-term losses to offset your long-term gains (and vice versa) as well.
If you still have losses left over after going through this process, then you can use those additional losses to offset your total tax obligation, up to $3,000 for 2019 (for those who are filing as married filing jointly). The deduction is cut in half for those who file as a single person or married filing separately.
Getting Investment and Tax Planning Help
Dechtman Wealth Management helps you consider all of the benefits and drawbacks of a particular type of investment, including the tax implications. If you would like more information or help planning for your future, give our financial professionals a call today.