Tax Savings for Young Families

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By the Editors of Kiplinger's Personal Finance magazine

Young families should make these moves throughout the year to keep their tax bills low at tax time. Here are the areas where you should look for savings:

WORK

Give yourself a raise.
If you got a big tax refund this year, it meant that you're having too much tax taken out of your paycheck every payday. Filing a new W-4 form with your employer (talk to your payroll office) will insure that you get more of your money when you earn it. If you're just average, you deserve about $225 a month extra. Try our easy withholding calculator now to see if you deserve more allowances.

Go for a health tax break. Be aggressive if your employer offers a medical reimbursement account -- sometimes called a flex plan. These plans let you divert part of your salary to an account which you can then tap to pay medical bills. The advantage? You avoid both income and Social Security tax on the money, and that can save you 20% to 35% or more compared with spending after-tax money. The maximum you can contribute to a health care flex plan is $2,500.

Change in family = change in flex plan. If you get married or divorced, or have or adopt a child during the year, you can change the amount you're setting aside in a medical reimbursement plan. If you anticipate more medical bills, steer more pretax money into the account; if you anticipate fewer, you can pull back on your contributions so you don't have to worry about the use-it-or-lose-it rule.

Pay child-care bills with pre-tax dollars. After taxes, it can easily take $7,500 or more of salary to pay $5,000 worth of child care expenses. But, if you use a child-care reimbursement account at work to pay those bills, you get to use pre-tax dollars. That can save you one-third or more of the cost, since you avoid both income and Social Security taxes. If your boss offers such a plan, take advantage of it.

Switch to a Roth 401(k). But if you are concerned about skyrocketing taxes in the future, or if you just want to diversify your taxable income in retirement, considering shifting some or all of your retirement plan contributions to a Roth 401(k) if your employer offers one. Unlike the regular 401(k), you don't get a tax break when your money goes into a Roth. On the other hand, money coming out of a Roth 401(k) in retirement will be tax-free, while cash coming out of a regular 401(k) will be taxed in your top bracket.

Stash cash in a self-employed retirement account. If you have your own business, you have several choices of tax-favored retirement accounts, including Keogh plans, Simplified Employee Pensions, or SEPs, and individual 401(k)s. Contributions cut your tax bill now while earnings grow tax-deferred for your retirement.

Pay tax sooner than later on restricted stock. If you receive restricted stock as a fringe benefit, consider making what's called an 83(b) election. That lets you pay tax immediately on the value of the stock rather than waiting until the restrictions disappear when the stock "vests." Why pay tax sooner rather than later? Because you pay tax on the value at the time you get the stock, which could be far less than the value at the time it vests. Tax on any appreciation that occurs in between then qualifies for favorable capital gains treatment. Don't dally: You only have 30 days after receiving the stock to make the election.

Hire your children. If you have an unincorporated business, hiring your children can have real tax advantages. You can deduct what you pay them, thus shifting income from your tax bracket to theirs. Because wages are earned income, the "kiddie tax" does not apply. And, if the child is under age 18, he or she does not have to pay Social Security tax on the earnings. One more advantage: The earnings can serve as a basis for an IRA contribution.

Pay back a 401(k) loan before leaving your job. Failing to do so means the loan amount will be considered a distribution that will be taxed in your top bracket and, if you're younger than 55 in the year you leave your job, hit with a 10% penalty, too.

Ask your boss to pay for you to improve yourself. Companies can offer employees up to $5,250 of an educational assistance tax-free each year. That means the boss pays the bills but the amount doesn't show up as part of your salary on your W-2. The courses don't even have to be job-related and even graduate-level courses qualify.

Keep track of the cost of moving to a new job. If the new job is at least 50 miles farther from your old home than your old job was, you can deduct the cost of the move ... even if you don't itemize expenses. If it's your first job, the mileage test is met if the new job is at least 50 miles away from your old home. You can deduct the cost of moving yourself and your belongings. If you drive your own car, you can deduct 24 cents per mile for a 2013 move, plus parking and tolls.

Tally job-hunting expenses. If you count yourself among the millions of Americans who are unemployed, make sure you keep track of your job-hunting costs. As long as you're looking for a new position in the same line of work (your first job doesn't qualify), you can deduct job-hunting costs including travel expenses such as the cost of food, lodging and transportation, if your search takes you away from home overnight. Such costs are miscellaneous expenses, deductible to the extent all such costs exceed 2% of your adjusted gross income.

HOME

Use a Roth to save for your first home.
Sure, the "R" in IRA stands for retirement, but a Roth IRA can be a powerful tool when you're saving for your first home. All contributions can come out of a Roth at any time, tax- and penalty-free. %VIRTUAL-article-sponsoredlinks%And, after the account has been opened for five years, up to $10,000 of earnings can be withdrawn tax- and penalty-free for the purchase of your first home. Assume $5,000 goes into a Roth each year for five years, and the account earns an average of 8% a year. At the end of five years, the Roth would hold about $31,680 -- all of which could be withdrawn tax- and penalty-free for a down payment.

Let Uncle Sam help pay for your home. A new home, whether it's your first or a trade-up, usually means a bigger mortgage. And that means a bigger mortgage interest deduction and maybe higher property taxes, too. You can adjust tax withholding from your salary to account for the new tax breaks, and beef up your take-home pay to help pay the bills.

COLLEGE SAVINGS

Save for college the tax-smart way. Stashing money in a custodial account can save on taxes. But it can also get you tied up with the expensive "kiddie tax" rules and gives full control of the cash to your child when he or she turns 18 or 21. Using a state-sponsored 529 college savings plan can make earnings completely tax free and lets you keep control over the money. If one child decides not to go to college, you can switch the account to another child or take it back.

DEDUCTIONS FOR NON-ITEMIZERS

Deduct expenses even if you don't itemize. Taxpayers who claim the standard deduction often complain that itemizers get the better deal. But that's not true. The only reason to use the no-questions-asked standard deduction is if it's bigger than the total you could deduct if you itemized. And, you can deduct a lot of things even if you don't itemize, including student loan interest, job-related moving expenses, costs incurred by reservists and performing artists and contributions to health savings accounts and IRAs. Casualty losses -- which used to be deductible only by those who itemize -- can also be added to the standard deduction. Keeping good records will save you money.

INHERITANCE

Roll over an inherited 401(k). A recent change in the rules allows a beneficiary of a 401(k) plan to roll over the account into an IRA and stretch payouts (and the tax bill on them) over his or her lifetime. This can be a tremendous advantage over the old rules that generally required such accounts be cashed out, and all taxes paid, within five years. To qualify for this break, you must name a person or persons (not your estate) as your beneficiary. If your 401(k) goes through your estate, the old five-year rule applies.

INVESTMENT AND RETIREMENT SAVINGS

Check the calendar before you sell.
You must own an investment for more than one year for profit to qualify as a long-term gain and enjoy preferential tax rates. The "holding period" starts on the day after you buy a stock, mutual fund or other asset and ends on the day you sell it.

Don't buy a tax bill. Before you invest in a mutual fund near the end of the year, check to see when the fund will distribute dividends. On that day, the value of shares will fall by the amount paid. Buy just before the payout and the dividend will effectively rebate part of your purchase price, but you'll owe tax on the amount. Buy after the payout, and you'll get a lower price, and no tax bill.

Beware of Uncle Sam's interest in your divorce. Watch the tax basis -- that is, the value from which gains or losses will be determined when property is sold -- when working toward an equitable property settlement. One $100,000 asset might be worth a lot more -- or a lot less -- than another, after the IRS gets its share. Remember: Alimony is deductible by the payer and taxable income to the recipient; a property settlement is neither deductible nor taxable.

Make your IRA contributions sooner rather than later. The earlier in the year your money is in the account, the sooner it begins to earn tax-deferred or, if you use a Roth IRA, tax-free returns. Over a long career, this can make an enormous difference.

YOUR CHILDREN

The stork brings tax savings, too.
A child born, or adopted, during the year is a blessed event for your tax return. An added dependency exemption will knock $3,900 off your taxable income, and you'll probably qualify for the $1,000 child credit, too. You don't have to wait until you file your return to reap the benefit. Add at least one extra withholding allowance to the W-4 form filed with your employer to cut tax withholding from your paycheck. That will immediately increase your take-home pay.

Tally adoption expenses. Thousands of dollars of expenses incurred in connection with adopting a child can be recouped via a tax credit, so it pays to keep careful records. The credit can be as high as $13,190. If you adopt a special needs child, you get the maximum credit even if you spend less.


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Tax Savings for Young Families
The Aloha State legislature, in an effort to preserve the uniqueness of their island paradise, has an "Exceptional Tree" tax allowance. Landowners can deduct up to $3,000 from their income for expenses such as pruning and fertilization for any tree designated as rare, big, old or a combination thereof. That's per tree. Top-bracket earners taxed at the state's highest rate (11 percent) would save $330 via the deduction.

The work must be done by a certified arborist, and the deduction can be claimed only every third year. The deduction was enacted in 2004. Hawaii has had a list of "Exceptional Trees" since 1975, and there are now estimated to be more than a thousand thus designated.
Maine legislators, a flinty bunch, don't see the harm in taxing anyone who deals in their official state fruit -- blueberries, at the rate of 1.5 cents per pound. The resulting revenues -- more than $1.6 million to state coffers in the fiscal year that ended in June 2013 -- are used to promote the crop and agricultural research.

The state also taxes harvesters and processors of hard-shell clams (known in the state as mahogany quahogs) at $1.25 a bushel, but state revenues for that are much lower. The taxes are levied at the wholesale level, but naturally, they end up being passed on to the consumer.
The Yellow Hammer State is the last in the union to tax a deck of cards as if it were a "vice," like alcohol and tobacco.

Taxing decks of cards, associated with gambling, was once fairly common, but most states have since set up separate control boards to regulate liquor and tobacco, and have let the cards slide.

But in Alabama, you'll still pay a 10 cent sales tax on any pack of cards you purchase. Retailers also have to pay $2 to the state each year for the privilege of selling playing cards.
"Merlyners" love their pollution-beleaguered Chesapeake Bay, the largest marine estuary in the U.S. In 2013, in part to meet federal pollution-control mandates, Free State legislators enacted fees on property owners in Baltimore and nine other Maryland counties, aimed at curbing storm water runoff. The fees were meant to fund programs to improve the water quality of the Bay.

Sounds simple enough, but the way Maryland legislators wrote the law has led to an angry backlash in some corners against this so-called "Rain Tax."

One way localities can calculate the tax is by measuring how much of a landowner's tract is "impervious" to precipitation seeping into the ground. So the more you've developed it with buildings, driveways, tennis courts and the like, the less it will absorb and the more you pay. That's how the tax is being implemented (through aerial and satellite photos) in Montgomery County, Md., a heavily developed suburb of Washington, D.C., and landowners are up in arms.

Other counties have rebelled, opting to pay for the pollution control programs out of general funds rather than pass the cost onto landowners. Maryland’s Republican candidate for governor, David Craig, has made the law's repeal part of his platform for the 2014 election.
The Sunflower State is among a bevy of jurisdictions that allows sale of lower-alcohol beer (the term of art is "cereal malt beverage") in convenience and grocery stores.

But Kansas also taxes "3.2" beer differently—and there lies the rub. At a liquor store, all products, including, say, a conventional six-pack of Budweiser (with 5 percent alcohol by volume), are taxed at a special rate of 8 percent. At the convenience store down the street, however, ordinary sales tax is levied on the lower-alcohol, cereal malt beverage bottle of Bud. That often ends up being more than the 8 percent alcohol tax. In Pomona, Kans., for example, the effective rate on the weaker beer would be 9.7 percent. Go figure.
When it comes to taxation, the rule is generally the stronger the booze, the higher the tax (that's why Kansas's beer tax scheme is an anomaly). California follows that curve, but at 100 proof, you better be ready to pay through the nose.

Distilled spirits are taxed at $3.30 a gallon if below 100 proof, or 50 percent alcohol. Go over that, like with Bacardi 151, and the tax doubles to $6.60. Maryland also notes the 100 proof point, but it only adds 1.5 cents per proof, per gallon to the relatively modest liquor tax of $1.50 per gallon, taking the Bacardi 151 to $2.27 per gallon.
Entertainment venues pay a business tax to the Silver State ranging from 5  to 10 percent on admissions fees (and food, drink and merchandise sales) whenever there’s live entertainment going on.

There are exemptions, however, including this one, for businesses that provide " ... Instrumental or vocal music, which may or may not be supplemented with commentary by the musicians, in a restaurant, lounge or similar area if such music does not routinely rise to the volume that interferes with casual conversation and if such music would not generally cause patrons to watch as well as listen."

So your piano player can play "Feelings" softly and even crack a few jokes, tax-free, for your business. Just make sure they're not funny enough to attract attention.
Want to own a plush or fuel-thirsty ride? That’ll cost you extra in the Garden State.

Cars that cost $45,000 or more or have a combined EPA fuel-mileage average of 19 or below pay an additional 0.4 percent on top of New Jersey’s 7 percent sales tax.
Businesses in D.C. that sell food or alcohol are required to charge customers 5 cents for every paper or plastic disposable bag they take. The store gets to keep a penny, and the balance goes to a government fund dedicated to cleaning up the Anacostia River.

Consumers and storekeepers grumbled at the program's debut in 2010. It has raised about $7 million so far, below expectations, but the program’s designers see this as a positive sign -- that shoppers have opted to bring their own reusable bags.
In the Land of Enchantment, making it to 100 years has a payoff beyond the chance that Willard Scott will wish you a happy birthday: You don't have to pay state income tax anymore.

If you've been physically present in the state for at least six months and a resident of the state on the last day of the year, and you’re not someone's dependent, you're eligible. You'll still need to file, and there are some complications if you're married and your spouse doesn't qualify.
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