How to Reduce Tax Liabilities
Updated on February 07, 2025
Reviewed by:
Aya Takriti, an IRS Enrolled Agent with 11 years of expat tax experience, specializes in US tax preparation, tax planning and tax advice for US citizens and Green Card holders living and working in the Middle East. *Schedule a consultation with Aya today.
*30-minutes US$247.
Table of Contents
How can I reduce my tax liabilities?
There are strategies you can apply to lower your taxes, such as claiming deductions and tax credits or earning tax-free income.
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. There are proven and legal ways to minimize your tax liability, like exclusions, credits, and deductions.
How does a tax exclusion work?
A tax exclusion removes a specific type of income from your taxable income to reduce the income subject to tax. Americans abroad commonly claim the Foreign Earned Income Exclusion (FEIE) and Foreign Housing Exclusion (FHE).
Am I eligible to claim the Foreign Earned Income Exclusion (FEIE)?
If you are a US expat with foreign-earned income from wages or self-employment income, you can generally claim the FEIE. This exclusion allows you to subtract income earned and taxed in a foreign country from your US taxable income.
For 2025, you can exclude up to US$130,000 from your US taxable income.
What is the Foreign Housing Exclusion (FHE)?
The Foreign Housing Exclusion (FHE) is another tax exclusion that helps American expats reduce their total US taxable income. This exclusion reduces housing expenses like rent, utilities, or repairs incurred in a foreign country.
The amount you can exclude for the FHE is determined by computing your base housing amount from your total foreign housing expenses for the year. This base housing amount is linked to your maximum FEIE.
So, the FHE works alongside FEIE to reduce the overall tax liability of US citizens living abroad.
Can I claim the FHE as self-employed in another country?
Yes, but for self-employed individuals, the housing expenses are treated as a deduction rather than an exclusion, lowering taxable income but not reducing your gross income.
Which tax credits are currently available to taxpayers?
Tax credits are used to lower your taxes dollar for dollar. IRS tax credits include:
- The child tax credit (CTC) and additional child tax credit (ACTC)
- Earned income tax credit (EITC)
- First-time homebuyer credit
- Education credit
- Child and dependent care credit
- Lifetime learning credit (LLC)
- Adoption credit
- Retirement savings contributions credit
- American Opportunity Tax credit (AOTC)
- Residential clean energy credit
It is important to note that you’re still eligible for tax credits even if you don’t itemize on your tax return.
Can I claim the Foreign Tax Credit (FTC)?
Again, you can claim the credit if you are a US citizen or resident alien with foreign income. The FTC is a non-refundable credit for income taxes paid to a foreign government.
The amount you can claim for the FTC should not exceed your total US tax liability multiplied by a fraction. The fraction’s numerator is your taxable income from outside the US, and the denominator is your total taxable income from US and foreign sources.
Can US expats claim the Child Tax Credit?
Yes, US citizens and Green Card holders living outside the US can claim the Additional Child Tax Credit (ACTC). This refundable credit was created to relieve parents and guardians of dependent children financially.
For tax year 2025, the maximum refundable credit is US$1,700 per eligible child or dependent. However, claiming the FEIE alongside it may reduce the CTC or ACTC amount.
Can tax treaties reduce my US tax liabilities?
Yes, tax treaties between the US and other countries can help reduce tax liabilities by eliminating double taxation on certain types of income, such as pensions, social security benefits, interest, dividends, and capital gains.
Tax treaties can also reduce liability through reduced tax rates or exemptions for specific income categories. Some treaties lower or eliminate withholding taxes on dividends or interest earned in the treaty country, which can reduce the overall tax burden for US citizens earning investment income abroad.
Stay on track with the best strategies to reduce your tax liabilities based on your unique tax situation.
How can I earn tax-free income?
Some gains are not subject to income tax, and certain tax policies can help you avoid paying capital gains 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 if you’re eligible.
- Open a health savings account.
- Open a Flexible Spending Account (FSA).
- Take advantage of employer benefits such as insurance plans, dependent care, and educational assistance.
How do I open a Health Savings Account? (HSA)
You need to determine your eligibility, which includes being enrolled in a High-Deductible Health Plan (HDHP) and not having secondary health insurance. Choose HSA providers like Fidelity, Lively, or HSA Bank, then follow their requirements to open an account and contribute.
This is a good way to lower taxable income and reduce tax liabilities as contributions from HSAs are tax-deductible, earnings grow tax-free, and withdrawals for qualified expenses are tax-free.
What is a Flexible Spending Account (FSA)?
A Flexible Spending Account (FSA) is another tax-advantaged account which helps reduce taxable income by setting aside pre-tax dollars for eligible expenses.
There is a healthcare FSA and a dependent care FSA, which help cover medical, dental, vision, and dependent care expenses that might otherwise be out-of-pocket.
How does contributing to a retirement account work?
Contributing to retirement accounts can reduce your taxable income and lower your taxes. There are employee-sponsored plans like a traditional 401(k) or 403(b) plan. Still, if an employer-sponsored plan isn’t available to you, you should consider a traditional individual retirement account (IRA) instead, which offers similar benefits.
Contributing to a traditional 401(k) plan through your paychecks offers a dollar-for-dollar reduction in your taxable income. The Roth 401(k) or 403(b) don’t provide upfront tax benefits but allow for tax-free withdrawals later.
Contributions to a traditional IRA will be made with pre-tax dollars. This means that you will have less taxable income and lower tax liability.
Can I change my tax residency to reduce taxes?
Yes, but it requires careful planning and adherence to the jurisdictions’ tax laws. Many individuals, like expats and retirees, strategically relocate to countries or states with favorable tax systems to potentially lower taxes.
This requires legal compliance and a clear understanding of the tax laws in both your current and new jurisdictions. Consulting with a tax professional or legal advisor is recommended for this strategy.
Can I get a credit for higher education?
Yes, 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 four years of college, and the maximum credit per student per year is US$2,500.
Another credit is the lifetime learning credit, an excellent option for adults continuing their education or training. This credit can be used for college and educational expenses that improve job skills, and the maximum credit is US$2,000 per return.
What is an educational savings account?
An Educational Savings Account (ESA) is a tax-advantaged savings account that focuses on covering expenses for primary, secondary, and higher education. A common one is a 529 plan.
You can fund educational savings plans like 529 plans by contributing cash and investing it in stocks, bonds, and mutual funds.
Are municipal bonds tax-free?
Yes, the benefit of municipal bond interests is that it’s exempt from federal income tax. In some cases, it is also exempt from state and local taxes if the investor resides in the state where the bond was issued, which can reduce your overall tax liabilities.
Can donating to charity lower my tax bill?
Yes, The IRS allows taxpayers to make itemized deductions for any donations 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 US$250 in value requires a receipt to be a valid deduction.
Can I profit from investment losses?
Yes, you can reduce your tax liability for the given year when you sell off investments that have declined 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 US$3,000 for single filers or married filing jointly and US$1,500 if you’re married filing separately, and you can carry additional losses forward.
Can I deduct business expenses from my taxable income?
Yes, business expense deductions are totally acceptable, provided that they are ordinary and necessary for your business operations.
Now, it depends on the kind of business you’re in to check the qualifications for an ordinary and necessary expense. A rule to identify is that it is a common and accepted expense in your industry, and it should be helpful and appropriate for your business operations.
