While paying taxes is a civic obligation, it isn’t usually a pleasurable experience. But that stack of paperwork could lead to significant tax savings.
Fortunately, there are proven and legal ways to minimize your tax liability.
Here are 20 strategies you can apply to help lower your taxes.
Earn tax-free income
Some of the gains you make aren’t subject to income tax, and you can take advantage of certain tax policies to avoid paying capital gains tax or income tax, lowering your tax liability.
You can also:
- Invest in tax-free bonds
- Put money towards your child’s education with a 529 Plan
- Open a health savings account
- Take advantage of employer benefits such as insurance plans, dependent care assistance and educational assistance
Tax deductions reduce your taxable income. Generally, you can take a standard deduction or itemized deductions. Itemized deductions include costs for medical and dental care, property taxes, state income taxes, mortgage points and mortgage taxes, business expenses and charitable contributions.
Maximize tax credits
Tax credits are used to lower your taxes dollar for dollar. IRS tax credits include:
- The child tax credit (CTC)
- Earned income tax credit (EITC)
- First-time homebuyer credit
- Education credit
- Child and dependent care credit
- Adoption credit
- Retirement savings contributions credit
The credits available change every tax year, so make sure to check that the credits you are relying on will be available for the given tax year.
Contributing to a retirement account – 401k or IRA
By contributing to a 401k retirement account (employer-sponsored) or individual retirement account (IRA), you can reduce your taxable income and lower the taxes you owe. Pre-tax money is deposited into the 401k account and growth is tax deferred. An individual retirement account offers similar benefits.
Following the Setting Every Community Up for Retirement Enhancement Act (SECURE) of 2019, seniors can now contribute to IRA accounts indefinitely. This new law also raised the age that seniors must take required minimum distributions (RMD) from their 401(k) and IRA accounts. In the past, RMDs had to be taken at age 70 ½ – the age has now increased to 72 years.
Opening a health savings account
Contributing to a health savings account, if you have an eligible high-deductible medical plan, is another way to lower taxable income. Contributing to these accounts provides an immediate tax deduction, they grow tax-deferred, and withdrawals for qualified medical expenses are tax-free. Any balance left at the end of the year is rolled over indefinitely.
Contributing to employer-sponsored plans
Contributing to a traditional 401(k) or 403(b) plan through your paychecks offers a dollar-for-dollar reduction in your taxable income. The Roth 401(k) or Roth 403(b) don’t provide upfront tax benefits; however they do allow for tax-free withdrawals later on.
If an employer-sponsored plan isn’t available to you, you should consider a traditional IRA instead. Any contributions to these will be made with pre-tax dollars. This means that you will have less taxable income and lower tax liability.
Profiting from investment losses
You can reduce your tax liability for the given year when you sell off investments that have declined in value since you purchased them. This strategy is often referred to as ‘tax-loss harvesting’. The IRS allows these investment losses to be written off against investment gains up to a certain limit each year. The limit is $3,000 or $1,500 if you’re married filing separately.
Check for flexible spending accounts at work
You can lower your taxes by paying into a tax-free health flexible spending account (FSA). Generally, contributions made into these aren’t subject to employment or federal income taxes.
If your employer participates, you can voluntarily elect to contribute a certain amount of money into the account at the start of the year. During the year, your employer will periodically deduct a payment for the elected amount from your paycheck. If you change your mind, you’re able to receive the maximum reimbursement at any time.
Claiming business deductions
You can engage in freelance projects on the side to take advantage of tax deductions available to self-employed individuals (even part-time).
Claiming home office deductions
Costs incurring from a home office that is used regularly and exclusively for business purposes can be deducted. For example, if you are using an extra bedroom that is one-sixth of your living space, you can deduct one-sixth of your rent and utility fees.
Rent out your home for business meetings
Homeowners can rent out a space in their home for 14 days and not report this income to the IRS. However, the home can’t be the owner’s primary place of business. This means that for business owners without a home office, this is a great way to reduce taxes. They can rent out a room in their house for business meetings, deduct the cost from their business taxes, and not need to include the rental fees on their personal tax return.
However, the price paid by the business for the meetings needs to be in line with rental rates charged by comparable spaces in your market, and you’ll need to keep a detailed record of this when the meeting took place.
Donating to charity
By donating to a charitable organization, you can lower your taxes.
The IRS allows taxpayers to make itemized deductions for any gifts made to a qualified charitable organization on their tax returns
Taxpayers who itemize can deduct donations of money, stock, or noncash contributions (such as used clothing and household items), and sometimes out-of-pocket expenses such as transportation costs. Any donation exceeding $250 in value requires a receipt to be a valid deduction.
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Pay medical bills
When itemizing deductions, deducting medical expenses is a good way to lower your taxes. According to the IRS, medical expenses are costs incurred for diagnosis, treatment, cure, mitigation or the prevention of a disease. Taxpayers can deduct medical and dental expenses that exceed 7.5% of their adjusted gross income. Qualifying expenses are those for yourself, a spouse or your dependents, and are eligible for deduction in the year they were paid.
Get a credit for higher education
The US government provides tax credits to offset the cost of higher education (the American opportunity tax credit). This credit can be claimed for the first 4 years of college and the maximum credit per student per year is $2,500.
The lifetime learning credit is a great option for adults who are continuing their education or training. This credit can be used for college and educational expenses that are improving your job skills and the maximum credit is $2,000 per year.
These credits are deducted from any tax you owe the government. In the case that it exceeds the amount of taxes you owe, $1,000 may be refunded to you.
Itemize state sales tax
Taxpayers who itemize deductions can include either their state income tax or state sales tax on their Schedule A form.
Deducting private mortgage insurance premiums
You most likely pay private mortgage insurance if you have less than 20% equity in your home. Although itemized deductions for the cost of private mortgage insurance were eliminated in 2017, it has been reinstated by Congress and will be available again for the tax year 2021.
Donating stock to avoid capital gains tax
By using stock to make charitable gifts, you are also able to avoid capital gains tax.
Money that is moved into a donor-advised fund is exempt from capital gains tax and can also be deducted by those who itemize. Depending on the firm you use, donor-advised funds can be started with as little as $5,000.
Investing in qualified opportunity funds
Although qualified opportunity funds aren’t accessible to everyone, investors can save loads. For example, investing in real estate is extremely tax advantaged.
Qualified opportunity zones were created by the Tax Cuts and Jobs Act of 2017. Through this, investors can move eligible gains (for example, money from the sale of stocks) into qualified opportunity funds which invest in projects in these areas. By doing this, you’re able to defer the payment of capital gains tax on that money for up to 10 years. After these 10 years, subsequent gains on the investment may even be tax-free.
Claiming deductions for military members
If you are in the military reserves (for example, the National Guard), and travel over 100 miles from home to be away overnight, you can deduct unreimbursed travel expenses. These expenses include transportation, meals and lodging.
If you’re an active-duty service member, you can deduct any costs incurred from moving for a permanent change of station.
State and local tax breaks
You may also be able to reduce your state and local tax burden.
Federal tax reform laws eliminated miscellaneous deductions; however many states still allow them. In New Jersey, taxpayers can deduct the cost of medical expenses that exceed 2% of their adjusted gross income – whereas on federal tax forms, medical expenses need to be in excess of 7.5% of your income to be deductible.
The tax savings here aren’t just for income taxes. For example, in New York City, there is a parking tax for some rented spaces. Residents can request an exemption and waive a portion of the fee.
Check with your local and state taxing authorities to see what deductions may be available.