Q: Tax Playa, I know that I have to pay taxes on my wages. What are some ways that I can cut back on the tax bite?
Jane, Arlington VA
A. Wages are fully taxable, of course. It's what most of us pay most of our taxes on. However there are several categories of ways to save money on wages: pensions, health care, other fringe benefits, and reimbursement plans.
Let's look at the rules for each:
1. Pensions. Pensions, or workplace retirement plans, take many forms. In general, they can be divided into defined benefit pensions (where a set amount of retirement income is promised) and defined contribution pensions (where a set amount of contributions are made). Defined benefit plans are going the way of the dodo bird, so I will focus on defined contribution plans.
The most common kind of defined contribution pension is the 401(k) plan. In this plan, employee can defer up to $15,500 (for 2007) in salary to go toward the plan. The deferral can either be pre-tax (reducing your pay and taxes owed), or "Roth" style, where taxes are paid but no tax is due in retirement. In addition, workers over age 50 can elect to defer another $5000.
Additionally, your employer may opt to match your 401(k) contribution. A very common arrangement is for your employer to match 50% of the the first 6% of your salary that you defer.
Once money is contributed you can choose from a menu of investment options. When you change jobs, you can either roll the plan into your new 401(k), or roll it into an IRA. Click here for more information on these plans.
2. Health Care. There used to be a time when employers would pay for all health care costs for employees, their spouses, and their children. Thanks to the escalating cost of health insurance, those days are gone.
A more likely arrangement is a cost-sharing between the employer and the employee. The good news is that any employee contributions done via a "cafeteria plan" (using a payroll service) is automatically pre-tax.
An even better option is if employees can put money in a health savings account, or HSA. Click here for more information on these plans.
3. Other Fringe Benefits. By far, the most important fringe benefits offered at work are pension and health care-related.
There are, however, other fringe benefits that can be provided by your employer and not be taxable to the employees. In the case of some of these benefits (like parking and public transportation), these can be provided as a salary deferral option.
For more on these and to see if you can get your employer to offer them, consult IRS Publication 15B: Employer Guide to Fringe Benefits.
4. Reimbursement Plans. Most employers will reimburse their employees for legitimate business expenses (business travel, business meals, training, etc.) Be sure that you get so reimbursed.
If your employer is a jerk and doesn't reimburse these items (or simply disagrees on their business necessity), you can always deduct them on your taxes as an unreimbursed employee business expense. However, most people can't benefit from this because either they don't itemize, or they can't overcome the 2% of AGI floor to claim benefits.