Paying taxes, while a civic duty, isn't always an enjoyable experience, mostly because of the complicated paperwork involved. However, that stack of papers could unlock considerable tax savings, with theproper planning and strategies. Here's an introduction to some basic strategies that could help lower your taxes.
1. Earn Tax-Free Income
Some gains are notsubject to income tax. By taking advantage of certain tax policies, you can avoid capital gains tax or income tax to lower your tax liability. This includes selling your primary home to avoid capital gains taxes (subject to restrictions). You could also invest in tax-free bonds, put money towards your child's education with a 529 plan, open a health savings account, or take advantage of certain employer benefits like insurance plans, dependent care assistance, and educational assistance.
2. Contribute to a Flexible Spending Account
Another easy way to lower your taxes is to pay into a tax-free health flexible spending account (FSA). Contributions made to a flexible spending account are generally not subject toemploymentor federal income taxes.
If the employer participates, an employee can voluntarily elect to contribute a certain amount of money into the account at the beginning of the year. During the year the employee participates, the employer will periodicallydeduct a paymentfor the elected amount from the employee's paycheck but the employee can receive the maximum reimbursement at any time.
3. Maximize Deductions
Tax deductions reduce taxable income. The amount saved in taxes depends on the taxpayer's tax rate. A taxpayer can generallytake a standard deductionor can take itemized deductions. Itemized deductions can include costs for medical and dental care, mortgage points, mortgage interest, property taxes, state income taxes, charitable contributions, and business expenses.
Find out whether a standard deduction or itemized deduction is better for your bottom line.
4. Maximize Tax Credits
Atax creditcan lower your taxes dollar for dollar. The government uses tax credits to encourage taxpayers to engage in certain activities or to grant tax relief.
Some of the IRS tax credits include the child tax credit (CTC),earned income tax credit, first-time homebuyer credit, child and dependent care credit, adoption credit, education credit, and retirement savings contributions credit. Tax credits and deductions available change regularly. Check to make sure the credits you are relying on will be available for any given tax year.
5. Contribute to a 401k or IRA
Contributions to a401k retirementaccount orindividual retirement account(IRA) can help lower your taxes by reducing taxable income. The pre-tax money is deposited directly into the 401k account and the growth is tax-deferred. An IRA offers similar benefits and each type of plan is subject to contribution limits and early withdrawal penalties.
6. Donate to Charity
Donating to a charitable organization can also lower your taxes. The IRS allows taxpayers to make itemized deductions on their tax returns for gifts made toqualified charitable organizations. A taxpayer can deduct donations of money, stock, or noncash contributions and, in some cases, out-of-pocket expenses like transportation costs.
7. Pay Medical Bills
If you itemize deductions, deducting medical expenses can lower your taxes. The IRS defines medical expenses as costs incurred for diagnosis, treatment, cure, mitigation, or the prevention of a disease. The taxpayer candeduct medical and dental expensesthat exceed 7.5% of their adjusted gross income. Qualified expenses include those for yourself, a spouse, or dependents. Regardless of when the taxpayer incurs the medical costs, the expenses are eligible for deduction in the year paid.
8. Sell Losing Investments
A taxpayer can reduce tax liability withlosses sustained on an investment. To qualify for the deduction, the taxpayer must have taxable gains and losses. The IRS allows taxpayers to use a capital loss to offset capital gains. If the loss exceeds gains, the taxpayer can deduct the loss against ordinary income. It is permissible to carry over a loss to later years if it exceeds the limit.
9. Reduce Your Tax Rate
Because federal income tax rates vary, it's possible to lower your taxes by reducing your tax rate. Income tax rates and short-term capital gains for 2020 range from 10% to 37%. The IRS assesses tax on income earned from work at an ordinary income rate of up to 37%. Long-term capital gains tax rates range from 0% to 20%, based on income levels. This lower tax rate applies to income earned on stocks, bonds, mutual funds, and real estate investments. The rates depend on the taxpayer's tax bracket and the holding period for the investment.
10. Income Shifting
Hiring your child to work for your business can also lower your tax bracket. This is a type of income shifting. Shifting income accomplishes two goals: it reduces tax liability and decreases a taxpayer'sadjusted gross income. However, there are several restrictions on income shifting.
Let an Attorney Help You Lower Your Taxes
There are a number of ways to reduce your tax exposure, but these can shift as laws change. As you sit down to work on your tax planning, having a qualified tax attorney at the table with you can make all the difference. Get your questions answered and start the process of lowering your tax burden by speaking with a localtax law attorney.