After the revelry of the Mardi Gras subsides, it’s time to turn your attention toward something less festive: tax season. However you feel going into it, everyone has the same goal: maximize my refund and minimize my tax liability.
If you haven’t thought much about your taxes, or have yet to create a tax savings strategy, below are a few considerations to make. Plus, we offer five tips for managing that refund once it comes your way.
What to Know About Louisiana State Taxes
If you’ve recently moved to Louisiana or simply never put much thought into your state taxes, here’s a quick assessment of Louisana’s taxes.
The individual income tax is on a graduated scale, ranging from 1.85% to 4.25%. If you’re a business owner, your company may also be subject to corporate income tax, which ranges from 3.5% to 7.5%.1
The state sales tax rate is 4.45%. The local sales tax rates are some of the highest in the country, with an average combined rate of 9.55% for state and local sales tax.1
The average household income in Louisiana is $51,730. Based on the state tax information shared above, the total income taxes paid is, on average, $10,022 for single filers and $8,044 for joint filers.2
Tips for Maximizing Your Refund
It’s true that if you overpay your taxes throughout the year, you’re likely to receive a refund come tax season. While that may seem reasonable, it can hurt your more significant financial goals.
Overpaying your taxes on purpose means allowing the government to borrow money from you interest-free. That’s money you could better use elsewhere, such as in a brokerage account or padding your retirement savings account.
Instead of overpaying taxes, here are a few more productive ways to maximize your tax refund.
Evaluate Your Tax Filing Status
This may seem like an obvious first step, but people don’t always choose the most beneficial status category following a marriage or divorce. But your tax filing status will affect the size of your refund, especially if you’re married.
While married filing jointly will be the most beneficial tax status for most married couples, this isn’t always the case. You and your spouse may experience more significant tax savings if you file separately in certain circumstances.
For example, couples earning about the same income may find that combining their income pushes them into an ideal tax bracket than filing separately. Or, if one spouse is on an income-driven student loan repayment plan, it may be worth filing separately (though this wouldn’t necessarily increase the size of your tax refund).
If you’ve recently experienced a divorce, another common consideration regarding filing status is choosing to file single or head of household. If you qualify for head of household, you’ll benefit from a higher standard deduction and more forgiving tax brackets.
To qualify for head of the household status, you’ll have to meet the following criteria:
- You were unmarried on the last day of the year of the taxes you’re filing for
- You have a qualifying dependent (such as a child)
- You pay for more than half of the household expenses (mortgage, utilities, groceries, etc.)
This status is commonly used by divorced parents, one of which has primary custody of a child.
Take Advantage of Tax Deductions
There are dozens of tax deductions available to taxpayers, but it’s not always obvious which ones apply to you.
Spend some time this tax season looking for available and applicable reductions. This may feel like a tedious and time-consuming process, but the tax savings are well worth the effort for many.
Common deductions to keep in mind are:
- State sales tax
- Out-of-pocket charitable contributions
- Student loan interest
- Medical expenses (exceeding 7.5% of your AGI)
- IRA contributions
Take the Qualified Business Income Deduction (If It Applies to You)
You may qualify for the Qualified Business Income deduction if you’re a small business owner. The IRS specifies that this deduction is for “sole proprietorships, partnerships, S corporations, and some trusts and estates.”3
It allows eligible business owners to deduct up to 20% of their qualified business income. In addition, they may deduct 20% of dividends earned from a qualified real estate investment trust (REIT) and qualified publicly traded partnership (PTP) income.3
Reduce Your Taxable Income
There are things you can be doing all year long to reduce your taxable income, primarily by maximizing contributions to your traditional IRA, 401(k), and/or your HSA.
Contributions to these accounts are made with pre-tax dollars, meaning you can deduct your contributions from your taxable income for the year they are made. In other words, you support your long-term retirement goals and create potential tax savings.
Remember that Roth accounts (such as Roth IRAs or Roth 401(k)s) are funded with after-tax dollars and will not reduce your taxable income for the year the contributions are made. The upside, however, is tax-free withdrawals in retirement.
Look Into Applicable Tax Credits
Like deductions, tax credits can help grow your tax refund.
Tax credits don’t reduce your taxable income since they are applied to your tax liability. For example, if you have a tax liability of $10,000 and are eligible for $6,000 in tax credits, your liability drops to $4,000.
While many tax credits are designed to assist lower-income taxpayers, it’s still worth looking into what you may be eligible for. If you meet the criteria, you want to take advantage of these offerings to help maximize your refund.
What Should You Do With Your Tax Refund?
Once you’ve spent time with your tax professional maximizing your tax refund, you’ll want to consider how to spend it. Your CFP® professional can help you identify your specific financial priorities. In the meantime, here are a few ideas to help get the wheels turning.
#1: Grow Your Emergency Fund
One of the first “to-do’s” on anyone’s list should be establishing an emergency fund. How much you decide to contribute is entirely up to you, though most people aim for the equivalent of three- to six-months salary. If you haven’t reached your goal yet, you may want to consider using your tax refund to pad your emergency savings.
#2: Pay Off Debt
If you have significant debt or high-interest loans, consider putting a portion or all of your tax refund toward paying it down. As a general rule of thumb, starting with the debt with the highest interest rate (typically credit cards or personal loans) is wise and working your way down from there. If you don’t have high-interest debt, you and your advisor may find it more prudent to use your refund elsewhere, such as your retirement savings.
#3: Put it Toward Your Retirement Savings
The more money you can put toward your retirement savings today, the more buying power you’ll have in the future. If you want to do something meaningful and long-lasting with your refund, adding it to your 401(k) or IRA doesn’t hurt.
#4: Invest It
You and your advisor may find putting your tax refund into a brokerage account beneficial. This will likely depend on your time horizon toward retirement and other financial priorities.
#5: Put it Toward Your Long-Term Savings Goal
Or, if you have a specific savings goal, your refund will be best served funding that instead. Maybe you want to buy a vacation home, save for your child’s college tuition, or renovate your family home. Whatever it is, your refund can be an excellent addition to meeting your goal.
Ready to Take on Tax Season?
While tax season may not be your favorite time of year, there are things you can do to help reduce your tax liability and grow your refund. And if you do receive a sizable refund this year, you and your advisor can determine the most effective way to spend or save it.
If you could use a second set of eyes on your financial situation or need a dedicated advisor to conquer your long-term goals, we’re always here to help. Feel free to reach out anytime.
Sources:
1Louisiana Tax Rates, Collections, and Burdens
2How much the average person from your state will pay in taxes