We are always talking about business owners and what tax strategies are available to them but I wanted to take a week off and talk about W2 employees. What tax strategies are available for W2 employees?
One thing to note is that for the most part, all of these strategies are still available for business owners! We are going to be discussing:
- Retirement Plans
- Health Savings Account
- Rental Properties
- Starting a Business
- Various Other Options
Before we get started we just want to let you know that these are the top strategies for those earnings $300k-$400k or less. Once you top the $400k mark it does open the door to some more advanced strategies that may be available to you on top of what we discuss here.
What Tax Planning Around Retirement Is Available for W2 Employees?
First things first, lets talk about the retirement option that most employers offer. This could be a SIMPLE IRA, 401k or 403b. Depending on your plan and options available you will have pre-tax contributions and potentially after-tax (Roth) contributions you can make.
- Pre-Tax Contributions: Any pre-tax contributions you make to a retirement plan will reduce your taxable income. Lets say you are in the 24% tax bracket and you make a contribute $10,000 into your pre-tax retirement account, you would save $2,400 in taxes that year. The downside here is that when you take this money out in retirement you get taxed. Think of this strategy as a tax deferral. Get a tax break today, pay taxes later.
- After-Tax Contributions (Roth): Any Roth contributions you make to a retirement plan do not reduce your taxable income. With that being said, when you start to take those funds out in retirement, you are not taxed. With this strategy you do not get a tax benefit today but you do later (pay taxes today, get a tax break later).
Many people will do a combination of the two. The other thing for W2 employees that we highly recommend is taking full advantage of any type of match your company is offering. This is free money into your retirement that your company is offering.
Outside of your company retirement plan you can also look at a Traditional or Roth IRA contribution. There are income limits on these that once you hit a certain income limit they may start to phase out or become not available. With that being said you also still have the backdoor Roth IRA option available even if you phase out. We talk about those limits and a backdoor in the articles below:
At the end of the day there is tax planning opportunities available with retirement planning, it just comes down to whether you want to have pre-tax or after-tax contributions (or some mixture of the two) and then we also suggest at a minimum, contributing up to your employer match.
What Tax Planning Around Health Saving Accounts Are Available for W2 Employees?
A Health Savings Account (HSA) is one strategy that we recommend both W2 employees and business owners max out if they qualify. We have an entire Blog and Podcast episode on this, What Is An HSA and How Do They Work?, but here is a summary:
- You get a tax deduction for the funds you contribute into an HSA.
- Withdrawals are tax free if used for qualified medical expenses.
- Interest or earnings with-in the HSA are NOT taxed.
It is a rare tool that the IRS lets you “win” on both ends, the contribution and the withdrawal. For this reason we recommend everyone be maxing out their HSA contributions, if they qualify and can afford it. The main thing is you need to have a high deductible health plan in order to qualify for an HSA.
Many people look at an HSA as a savings vehicle because there is no tax on the interest or gains earned within it and you know at some point you’ll need funds for medical expenses. This means that even if you do not have high medical costs today, it can still be a great savings vehicle.
What Tax Planning Around Rental Properties Is Available to W2 Employees?
We love the idea of using rental properties to not only save on taxes but also grow your wealth.We put together a whole series on this topic as part of our Ultimate Guide to Real Estate Taxes. I’ll touch on some of the high points here.
Rental properties often times produce losses in the early years because you are able to take advantage of depreciation on top of any other normal operating costs. The downside is that generally speaking, you cannot use passive losses (rental activity) to offset your W2 income. Now, this isn’t necessarily a bad thing because those passive losses will carry forward and offset passive income when they start to generate a profit.
With that being said, there are some strategies where you could use rental losses to offset W2 income:
- Active Investor: If you are under certain income limits you can claim up to $25,000 in rental real estate loss allowance from the property, if you “actively participate” in managing it.
- Real Estate Professional: Qualifying as a real estate professional allows you to fully deduct passive losses against your ordinary income. There are various requirements that need to be met to qualify.
- Short Term Rental: If you average rental is 7 days or less and you provide “substantial services”, any losses that occur within your short-term rental can be used to offset your W2 income.
With all of these they do have some things you need to ensure you are doing correctly so I highly recommend you check out our Ultimate Guide to Real Estate Taxes to learn more about the options here!
How Does Starting a Business Save Taxes?
As we talk about throughout our Blog and Podcast, starting a business is the easiest way to turn after tax spending into pre-tax spending. Essentially this allows you to get a tax deduction for spending you may be doing everyday but currently get no deduction for as a W2 employee.
Is there any side business you could start? A business does not have to be a full-time gig.
With a side business there would be potential that you could offset some or most of the income from it with spending that you may already be doing.
If you want to learn more about options here, continue to dig into all of our Podcast and trainings we do!
What Other Tax Planning Strategies Are Available for W2 Employees?
- Itemized Deductions vs Standard Deduction: You can claim standard deduction or itemized deductions, whichever is higher. If you have itemized deductions that are close to your standard deduction, consider “bunching” your itemized deductions in one year to increase that amount. Itemized deductions include:
- Medical & Dental Expenses (Above 7.5% of AGI)
- State and Local Taxes ($10,000 Maximum)
- Mortgage Interest
- Gifts to Charity
- Flexible Spending Account (FSA): Allows you to pay for certain items with pre-tax money. Essentially you get a tax deduction for the contribution and withdraws are tax free if used for qualifying expenses. However, the biggest downside is that it is a use it or lose it account so just ensure if you go down this route you are monitoring that and not putting more in than you can use. There are two types of FSAs that we see most often:
- Health Care FSA – This would be an alternative to the HSA if you do not qualify.
- Dependent Care FSA – This is for employment-related dependent care services. Some examples would be: after school programs, daycare, nanny, etc.
- College Savings: You can contribute to a 529 plan for college savings. There is no federal deduction for this contribution, but your state may offer a tax deduction.
- Advanced Planning: As we talked about in the beginning as your income starts to grow, it opens up the door to some more advanced planning that may be available to you. This could involve various types of tax advantage investments or charitable strategies.
For you W2 employees out there, hopefully this was helpful and gives you a little glimpse into how valuable tax planning can be for both you and your wealth!
- The Time Is NOW To Start Paying Less In Taxes. Join Our Tax Minimization Program (w/ Stress Free Bookkeeping Training)!
What you’ll get:
- Library of Tax Strategies, Implementation Guides, Videos, Downloads, etc.
- Stress Free Bookkeeping Training Program
- Ask A Pro – Unlimited email access to our team, it is like having an accountant in your back pocket!
- Monthly Group Trainings
- Private Facebook Group
- Partner Directory