Best way to reduce my tax liab.?

Question

Thanks to everybody for your advice..OK so please tell me the best way to save money / reduce my tax liab. with zero dependents. Any kind of investment but short term (1 or 2 yrs) or Roth IRA etc. I need money after such period so I will prefer with no penalty on withdrawl.

Answer 1

The only way to reduce your tax liability is to either have less income or more deductions than you had before.

One of the easiest ways to reduce your income is to contribute to a 401(k) or a traditional IRA. Since you don't want to pay a penalty on withdrawal, then those options are not available to you.

You may try to contribute to a Flexible Spending Account for medical bills. Also, you can see about having your medical insurance taken out pre-tax.

BTW, how do you know that you will need the money in a year or two?

Answer 2

You state you will need the money in 2 years. That is not a very long time in the investment world. Keep in mind that time can be your friend or enemy. The longer you own an investment the better your odds of a profit are. Of the things I will tell you about none of them are guaranteed. Personally I would concentrate on profit and not let my investment decisions rest on tax concerns. Every thing listed below is liquid, you can get your money back in a very short time except buying real estate.

Buy a house, when you sell your profit is tax free up to 250k if single or 500k if married. If you already own one wait a year and a half then sell, this will give the market a chance to recover. If you don’t own one and have good credit, find one that is already below market value and buy it. You will be able to deduct your mortgage interest, property taxes, and mortgage insurance (new deduction in 2007) if you can itemize. The down side; houses aren’t liquid investments; you can’t just hack off some 2x4’s and cash them in at Lowe’s. You might not be able to sell in time for the money you need (ask anyone who needs to sell now).

Buy stock in a good company, or buy index mutual funds; these are very liquid, you can get your money in less than a week. If you hold for more than a year your profit is taxed at maximum 15%, most dividends are taxed at the same rate (must be American companies). The down side; the stocks you pick might not be worth what they are now in 2 years, but if you sell at a loss you can use the loss to offset other income up to $3,000 per year and carry over the rest.

Invest in a Roth IRA; money put into a Roth grows tax deferred, if you hold until age 59 ½ and for five years it is tax free. If not you will have to add your profit to your income and pay a 10% penalty. You can always get the money you put into a Roth back with out any tax consequences. The down side; see houses and stocks.

But US Savings bonds; the interest you earn doesn't have to be reported until you sell the bond, savings bonds aren’t taxable in some states (tax free in IN for sure), and might be tax free on your federal return if used for education. The down side; it’s a interest vehicle, your principle is safe but you won't earn much interest.

Buy a bond or bond mutual funds; usually more stable than stocks, tax free bonds usually pay less interest than regular bonds and bond funds. The down side; if interest rates rise bonds usually lose value, and see Savings bonds.

Answer 3

if you want to save your money tax free invest in triple tax free municipal bond money market fund from one of the dozens of mutual funds companies out in the market.
if you can wait about 5 - 7 years, then you can try a tax free income fund instead of the money market.
The money market fund has little risk so is more appropriate for short term
The retirement accounts are not appropriate since (in general) you cant withdraw (without penalty) until age 59 1/2 (with some special exceptions) or for at least 5 years in the case of Roth IRA.

Answer 4

Some of my common tips:

- pay estimated state taxes before year end to get an extra itemized deduction (as long as it keeps you out of AMT)
- Invest in some energy friendly or energystar* approved home improvements such as A/C units. There are some sweet new tax credits available. This credit also applies to many hybrid cars
- Dump stocks at year end that produce a tax loss, you can deduct up to $3k of a loss against ordinary income which will reduce your tax burden.
- Take Sec 125 benefit option at work if it offers it. This allows you to put money aside from your paycheck into benefits like medical/dental/eye coverage and it will be all be tax free (ie taken away from gross wages on your W-2 so less income to report)
- Take $495 deduction for non-cash contributions ($500 or more you need proof =)

Good luck.

Answer 5

You can legally ELIMINATE your income tax liability by NOT HAVING an income. My point is, reducing you tax liability should not be your goal. You actually want to MAXIMIZE your after tax income. Because you want the money before retirement, AVOID all types of retirement accounts (401(k), IRA, Roth IRA).

Answer 6

Start a home-based business and learn about how to write off expenses. I did it, and now I can't wait to file next year!