Ways to decrease your Federal tax liability

[applecrispy]

Within the past year and a half DH's salary has more than doubled. We found out the hard way that not enough federal taxes were being taken out of his paycheck when we were surprised with a big fat Federal tax bill. The W-4 calculator is currently down on the IRS website but doing some quick and dirty math we need at least an additional $350 a month taken out of his paycheck to not owe any Federal taxes. (And he's supposed to get another raise in May which I haven't accounted for yet). I was so mad that we got dinged with a underpayment penalty as well. 

Together we make about $150k. We both are claiming 0 dependents (we don't have any) and married filing jointly. Should we change it to single or does it make more sense to use the W-4 calculator every year and adjust manually?

We are trying to find ways to decrease our tax liability. Currently we contribute to 401ks (not maxed out) and ROTH IRAs (not maxed out but that wouldn't decrease our tax liability anyway). We've never used a HSA before but maybe we can look into that in open enrollment at the end of this year. We hadn't considered IRAs because we wanted to max out the ROTH IRAs first. What do you do to decrease your tax liability? 

[allez]

While we file MFJ we use the single status to ensure that enough is withheld.  We also reduce tax liability by contributing extra to our 401k and HSA so I would definitely recommend that if you can afford to do so.  Also, depending on your employment (if in non-profit), you may have access to 403b and 457b accounts where you may also contribute to reduce tax liability so, if applicable, that would be something to consider as well.

[puppylove64]

We both withhold at the single rate. I would absolutely max out a HSA if you are eligible. It is not only excluded from income tax, but you don’t pay FICA on it either. Then I would look at increasing your retirement contributions. I would rather pay the money to myself than the IRS

[applecrispy]

Jan 21, 2022 12:43:21 GMT -5 ewall said:

Have you filed for 2021? Would it be worth it to do a traditional IRA contribution for 2021 to reduce your liability? At least then you would be paying yourself vs. taxes and maybe reduce the underpayment penalty?

To answer your question, we do 401k, HSA, and a limited FSA.

We have not filed for 2021 yet. I think that is a great idea- I forgot we could still make 2021 contributions until mid-April. I will definitely look into this, thank you!

[kadams767]

Jan 21, 2022 12:43:21 GMT -5 ewall said:

Have you filed for 2021? Would it be worth it to do a traditional IRA contribution for 2021 to reduce your liability? At least then you would be paying yourself vs. taxes and maybe reduce the underpayment penalty?

To answer your question, we do 401k, HSA, and a limited FSA.

A traditional IRA contribution likely wouldn't help them, they are above the income level for deducting those contributions in full and are covered by employer-sponsored retirement plans.

[applecrispy]

Jan 21, 2022 12:58:14 GMT -5 puppylove64 said:

We both withhold at the single rate. I would absolutely max out a HSA if you are eligible. It is not only excluded from income tax, but you don’t pay FICA on it either. Then I would look at increasing your retirement contributions. I would rather pay the money to myself than the IRS

I wish there were a calculator on DH's pay website that would allow us to play around with the single vs. married rate and withholding x number of dollars. It's better than having to change it and wait 2 weeks for a paystub to come out to see how it affects the total. And I completely agree- I would rather the money go towards something for myself (HSA, IRA retirement, etc) than the IRS. Thanks!

[applecrispy]

Jan 21, 2022 13:10:10 GMT -5 kadams767 said:

Jan 21, 2022 12:43:21 GMT -5 ewall said:

Have you filed for 2021? Would it be worth it to do a traditional IRA contribution for 2021 to reduce your liability? At least then you would be paying yourself vs. taxes and maybe reduce the underpayment penalty?

To answer your question, we do 401k, HSA, and a limited FSA.

A traditional IRA contribution likely wouldn't help them, they are above the income level for deducting those contributions in full and are covered by employer-sponsored retirement plans.

Thank you for pointing that out. I thought the income cap was much higher. I just looked on the IRS website and it looks like we wouldn't get any deduction at all due to the income limits. Darn!  

www.irs.gov/retirement-plans/plan-participant-employee/2022-ira-contribution-and-deduction-limits-effect-of-modified-agi-on-deductible-contributions-if-you-are-covered-by-a-retirement-plan-at-work

[goldengirlz]

It seems like maxing (or at least increasing) your 401k would be low hanging fruit …

[dcn]

Jan 21, 2022 13:12:06 GMT -5 applecrispy said:

Jan 21, 2022 12:58:14 GMT -5 puppylove64 said:

We both withhold at the single rate. I would absolutely max out a HSA if you are eligible. It is not only excluded from income tax, but you don’t pay FICA on it either. Then I would look at increasing your retirement contributions. I would rather pay the money to myself than the IRS

I wish there were a calculator on DH's pay website that would allow us to play around with the single vs. married rate and withholding x number of dollars. It's better than having to change it and wait 2 weeks for a paystub to come out to see how it affects the total. And I completely agree- I would rather the money go towards something for myself (HSA, IRA retirement, etc) than the IRS. Thanks!

Paycheckcity is a website where you can change the inputs to see what your net pay will be.

I’d max your 401(k) going forward or at least increase it.

[puppylove64]

applecrispy you can Google the IRS “circular e” it has tables that help determine what single vs married and different exemptions get you. The state will also have a similar table

[gt7301b]

Be careful with an HSA, you typically have to also have a high deductible insurance plan to have access to one. However, you can do an FSA without a high deducible plan, but it doesn't provide the same investment options.

www.investopedia.com/articles/personal-finance/082914/rules-having-health-savings-account-hsa.asp

Like a pp mentioned if you aren't maxing out your 401k that would be where I would start for reducing your tax liability.

[applecrispy]

Jan 21, 2022 14:08:06 GMT -5 goldengirlz said:

It seems like maxing (or at least increasing) your 401k would be low hanging fruit …

Yes, I'm definitely looking into that. Even if we both max out our 401ks we'll still owe but it's better than nothing!

[applecrispy]

Jan 21, 2022 14:13:36 GMT -5 dcn said:

Jan 21, 2022 13:12:06 GMT -5 applecrispy said:

I wish there were a calculator on DH's pay website that would allow us to play around with the single vs. married rate and withholding x number of dollars. It's better than having to change it and wait 2 weeks for a paystub to come out to see how it affects the total. And I completely agree- I would rather the money go towards something for myself (HSA, IRA retirement, etc) than the IRS. Thanks!

Paycheckcity is a website where you can change the inputs to see what your net pay will be.

I’d max your 401(k) going forward or at least increase it.

Thank you for that website recommendation! I've been playing around with different scenarios this morning. It's super helpful. Yes, we're definitely looking into maxing both of our 401ks. 

[applecrispy]

Jan 21, 2022 16:27:16 GMT -5 gt7301b said:

Be careful with an HSA, you typically have to also have a high deductible insurance plan to have access to one. However, you can do an FSA without a high deducible plan, but it doesn't provide the same investment options.

www.investopedia.com/articles/personal-finance/082914/rules-having-health-savings-account-hsa.asp

Like a pp mentioned if you aren't maxing out your 401k that would be where I would start for reducing your tax liability.

Thank you! I looked into the HSA requirements and our current insurance plan doesn't have high enough deductibles. I'll look into the FSA and we'll be looking into maxing both our 401ks as well. 

[dochas]

Jan 21, 2022 13:15:40 GMT -5 applecrispy said:

Jan 21, 2022 13:10:10 GMT -5 kadams767 said:

A traditional IRA contribution likely wouldn't help them, they are above the income level for deducting those contributions in full and are covered by employer-sponsored retirement plans.

Thank you for pointing that out. I thought the income cap was much higher. I just looked on the IRS website and it looks like we wouldn't get any deduction at all due to the income limits. Darn!  

www.irs.gov/retirement-plans/plan-participant-employee/2022-ira-contribution-and-deduction-limits-effect-of-modified-agi-on-deductible-contributions-if-you-are-covered-by-a-retirement-plan-at-work

Make sure you're looking at AGI, not salary. You still might be over, but if he got the raise late in the year maybe you could still contribute for 2021 and get the deduction. 

[sadlebred]

With the FSA, you may only be eligible and sign up during your company's open enrollment. Don't put in more than you think you would spend b/c most of the time it's spend it or lose it.

Although after tax, you could do more charitable deductions, increase your tithe to your house of worship if you have one, set up a monthly donation to the local food bank, etc.

[Susie]

If you're not maxing 401k, that's the first change to make.  We max our 401k/457b contributions, we max medical FSA, and we max dependent care FSA.  We end up able to use both of the latter two between various needs for our kids.

We also reduce state taxable income a little bit via 529 contributions.

[krystee]

For those of you saying to max your 401k, aren’t the tax-free gains you get by going with a Roth 401k if your company offers one better/higher in the long run than the money saved on taxes now if you go with the regular 401k? (This is a moot point if the company doesn’t offer one, but I’m asking for myself too since I currently contribute 100% to the Roth 401k, but my income is higher now than it will be in retirement, so maybe I shouldn’t?)

[kadams767]

Jan 23, 2022 8:45:02 GMT -5 krystee said:

For those of you saying to max your 401k, aren’t the tax-free gains you get by going with a Roth 401k if your company offers one better/higher in the long run than the money saved on taxes now if you go with the regular 401k? (This is a moot point if the company doesn’t offer one, but I’m asking for myself too since I currently contribute 100% to the Roth 401k, but my income is higher now than it will be in retirement, so maybe I shouldn’t?)

I am definitely hedging my bets and part of it for me is diversifying the types of retirement funds, but right now, I need the tax advantage of a traditional 401k.  I make way more now than I will in retirement, I am 100% certain of that.  So even if tax rates increase, I feel pretty confident that my tax savings now will outweigh what I’d get in retirement if I went Roth now.

Also, at a previous point in time, I continued to max a traditional 401k because it kept my AGI below thresholds needed for other things - a Roth IRA, deducting student loan interest, and some other things I can’t quite recall now.  

It’s definitely a guessing game, though, because who knows what taxes will look like when we are retirement age.  So I try to hedge my bets and do a mix of traditional and Roth.  Keeping in mind, I’m also fortunate to even be in a scenario to be concerned with this, given that it means I have a high enough income that it even crosses my mind to think about these kind of tax consequences, but really, the differences may be pretty minuscule in the long run.

[awkwardpenguin]

I think the best way to get your withholding right is to us the IRS withholding calculator. Run it in February or so and then again in September to make any needed adjustments. We fill out our W-4s as married 0 exemptions and then fill in the correct amount on the “additional withholding” line. The W-4 will almost always under-withhold for two earner households or people with multiple jobs. It’s annoying but the calculator is a good workaround.

With only W-2 income it’s very hard to reduce your tax liability. Max out all available tax-deferred investments, do an HSA or FSA if you are eligible, and make sure you are choosing the right option between the standard deduction and itemizing. After that, taxes are the privilege of being a high earner.

[Poppy]

Jan 23, 2022 8:45:02 GMT -5 krystee said:

For those of you saying to max your 401k, aren’t the tax-free gains you get by going with a Roth 401k if your company offers one better/higher in the long run than the money saved on taxes now if you go with the regular 401k? (This is a moot point if the company doesn’t offer one, but I’m asking for myself too since I currently contribute 100% to the Roth 401k, but my income is higher now than it will be in retirement, so maybe I shouldn’t?)

It depends. It usually makes sense to have some in non-Roth accounts because in retirement (as in your working years) you will pay graduated tax rates on your income. But it all depends on when you retire and whether you will have other income streams.

thefinancebuff.com/case-against-roth-401k.html

[gt7301b]

Jan 23, 2022 8:45:02 GMT -5 krystee said:

For those of you saying to max your 401k, aren’t the tax-free gains you get by going with a Roth 401k if your company offers one better/higher in the long run than the money saved on taxes now if you go with the regular 401k? (This is a moot point if the company doesn’t offer one, but I’m asking for myself too since I currently contribute 100% to the Roth 401k, but my income is higher now than it will be in retirement, so maybe I shouldn’t?)

We split our contributions between the Roth and the traditional for several reasons:

1) I think that tax rates will eventually increase, this is obviously just speculation on my part

2) We will probably actually be in a similar place income wise during retirement as we both have pensions

3) Roths are better assets to inherit and it is my hope we will be able to leave some money to DS

4) I have no idea what the optimal mix is so I just split it between the two

[lust2hart]

You could also increase your charitable giving.