Lowering your taxable income after that big raise

Q. I got a big raise, and I’m afraid it will put me into a higher tax bracket. What can I do to lower my taxable income?
— Worker

A. Congratulations on the raise.

You may not want to pay more in taxes, but if that’s your current money challenge because you’re earning more, that’s a good thing.

That being said, we all want to give as little to Uncle Sam as humanly possible.

There are several ways you can reduce your taxable income as a W2 employee, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

He said perhaps the biggest option for you is to maximize your employer-sponsored retirement plan contributions if you aren’t already doing so.

For 2016, you can contribute up to $18,000 to your 401(k) or 403(b) plan, plus an additional $6,000 catch-up contribution if you are over 50, he said.

“The money you contribute is not included in your taxable income,” DeFelice said.

If you also have any self-employment income from a side job or business, you can put away even more – up to 20 percent of your net self-employment income (after deductions) into a Simplified Employee Pension (SEP) up to a maximum of $53,000 (including any 401(k) contributions you also make), DeFelice said.

Another great way to lower your taxable income is to contribute to a Health Savings Account (HSA) if you have a high-deductible medical insurance plan.

“You can defer salary into a separate account using pre-tax dollars that can then be tapped into to pay for medical expenses incurred,” DeFelice said. “The contributions you made that aren’t used during the year for medical expenses can be rolled over indefinitely and grow tax-free, similar to the assets in a retirement account.”

DeFelice said you won’t pay taxes on the money put aside in an HSA as long as it used for IRS-qualified medical expenses such as deductibles, co-insurance, prescriptions, dental and vision care.

Your employer may even contribute to your HSA, but you own the account and the money is yours even if you change jobs. The maximum HSA contribution for 2016 is $3,350 for individuals and $6,750 for families, he said.

If you have young children, you should also check with your employer to see if it offers a Dependent Care Account.

“Similar to an HSA, a Dependent Care Account is a reimbursement type of account that will allow you to pay for eligible child care expenses using pre-tax dollars,” DeFelice said.

In 2016, you can defer up to $5,000 of your salary into a Dependent Care Account.

“This can easily save you one-third or more of your out-of-pocket cost, since you avoid paying both income and Social Security taxes on that money,” he said. “If your boss offers such a plan and you are paying for child care, you need to take advantage of it.”

You can also give some hard thought to what deductions you are taking come tax time.

“Unreimbursed vehicle expenses are often forgotten about when April 15 rolls around,” he said. “You can’t deduct your commuting costs to and from work, but if you travel to any satellite offices or drive your own vehicle for business trips or client meetings and aren’t reimbursed, you can deduct mileage costs.”

Another option is to try to plan your family vacation around a business trip wherever possible, DeFelice said. You can then reduce your vacation costs by deducting the percent of the unreimbursed expenses spent on business from the total cost of the trip. DeFelice said this could include airfare and part of your hotel bill proportionate to the time spent on business activities. It may not sound like much, but these types of deductions can add up over time if done consistently.

He said the best advice is to take some of that extra money from the raise and use it to hire a really good CPA.

“The tax code is ever changing and nearly impossible for the average person to keep up with. A savvy tax preparer can save you thousands of dollars over the long term, and should wind up being worth every penny you spend to hire one,” DeFelice said. “And don’t forget – those tax preparation fees the CPA charges you are also a deduction.”

Email your questions to ask@njmoneyhelp.com.

Karin Price Mueller writes the Bamboozled column for The Star-Ledger and she’s the founder of NJMoneyHelp.com. Click here to sign up for the NJMoneyHelp.com weekly e-newsletter. Like NJMoneyHelp.com on Facebook and follow it on Twitter.