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Tax Savings for Young Families

Take advantage of your flex account, save for college in a 529 plan and hire your children to lower your tax bill.

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Family calculating bills together
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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.
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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betty_brock

Did you see the video of the lady with 15 kids? She thinks the taxpayers owe her and her kids a living. That is what the Dems have given us. Generation after generation of deadbeats with their hands out.

Yes, it is relevant.

February 17 2014 at 9:06 PM Report abuse +1 rate up rate down Reply
Kevin P

Great advice. 529 vs Roth IRA vs Roth 401K vs Traditional 401k can be a tough decision to quantify. I've found SavingsMap to be incredibly useful at this. Free to use, but a very powerful forecasting site for personal finance....would definitely recommend it.

www.SavingsMap.com

February 17 2014 at 8:25 PM Report abuse +1 rate up rate down Reply
Iselin007

You know they don\'
t give a damn about Americans ever working again when they spen their entire tome in office kissing China, giving undocument aliens and visa workers access to the few jobs in this country!

And no my ancestors had a right to come here almost 400 years ago because England had discovered the Eastern coast of North America in the 1480\'s. If the Templars who came in the 1300\'s not been treated so harshly the claim who discovered America would of not been over shadowed by Columbus! As a direct descendant of one of the first lawful immigrants I should of priority on jobs!

February 16 2014 at 3:36 PM Report abuse -1 rate up rate down Reply
Iselin007

After NAFTA and the other trade deals all the retraining in the world isn\'t going to get you back on track. Promises of a recovery went out the window years before this current lie of economy. You can\'t recover when their still promising because they don\'t have nothing to show for it but generations of ruined careers and wasted education.

You spent most of your life working an now you spent money on an education that has only gone out the window so cheap slave labor can benefit from your jobs!

February 16 2014 at 3:27 PM Report abuse -1 rate up rate down Reply
Iselin007

The EBT that was paid while I was in school was assumed to be income along with the unemployment. When the total sum of income from EBT and Unemployment was added for tax purposes a certain amount would of been an overpayment requiring a refund. IRS notifys me I owe money! WTF? I paid the amount but still don\'t friggin understand why the total amount paid in did not count!

February 16 2014 at 3:16 PM Report abuse rate up rate down Reply
alfrankenfool

Don't work like Evan, aka Teapot etc.

February 16 2014 at 2:50 PM Report abuse rate up rate down Reply
jrb359

Best ways to save on taxes is to not vote for a lieing, deceiving, tax and wastefully spend Democrat. Another thing would be to not let the IRS know that you don't agree with Democrats because then they will want to audit you! Be sure to thank anyone who voted for this president.

February 16 2014 at 2:25 PM Report abuse +2 rate up rate down Reply
Iselin007

Just leaving a state that taxes you up the wazzoo will save you on future costs. When they outsource your career you'll only spend more trying to chase a non existant replacement career.

February 16 2014 at 1:33 PM Report abuse +2 rate up rate down Reply
Iselin007

Nice try however your just as exposed as anyone else in this great recession.

February 16 2014 at 1:26 PM Report abuse +1 rate up rate down Reply