Looking for ways to slash your tax bill? Laura reviews seven legitimate ways to eliminate your entire tax bill or increase your tax refund and keep more of your money.
While paying taxes that you legally owe the tax authorities is critical, there’s no need to pay more than you owe. While evading taxes is a crime, it’s not against the law to use legit strategies to minimize your federal or state taxes.
This post will cover seven legal ways to reduce your taxes. Depending on your eligibility for tax benefits, using them could save hundreds or thousands of your hard-earned dollars. Using one or two tips could help you eliminate your entire tax bill or increase your tax refund.
Here are the details on each of these legit ways to lower or eliminate your tax liability.
1. Contributing to retirement accounts
Making contributions to one or more retirement accounts is one of the best ways to skip taxes and boost your future financial security. I’m a huge fan of participating in workplace retirement plans, such as a 401(k) or 403(b). They come with high contribution limits, and many employers pay some amount of matching funds to sweeten the deal.
Just about everyone with earned income (or a spouse with income) can put money into an individual retirement account or IRA. That includes employees who don’t have a retirement account at work and the self-employed. There are even more options when you work for yourself part- or full-time, including a SEP-IRA and a solo 401(k).
So, how exactly does using a retirement account cut your taxes? With traditional accounts, such as a traditional IRA or 401(k), your contributions are tax-deductible. That means you don’t pay taxes on them in the current year.
For instance, if you earn $80,000 and max out a 401(k) with contributions of $20,500, you only pay taxes on $59,500 of income—not $80,000. For 2022, if you’re over age 50, you can contribute $6,500 more, for a total of $27,000. What’s not to love about that?
2. Using medical spending accounts
Some employers offer a flexible spending account (FSA) to help workers avoid tax on funds used for certain medical and child care expenses. You and your employer can make tax-free contributions if you spend them on eligible costs by an annual deadline.
If you purchase a high-deductible health plan as an individual or through an employer’s group plan, you can contribute to a health savings account (HSA). It’s similar to an FSA but doesn’t have a “use-it-or-lose-it” spending deadline. Your unused HSA balance can roll over from year to year with no penalty.
Using an FSA or HSA helps you reduce taxes because your (or your employer’s) contributions get excluded from your taxable income. However, there are penalties for making non-qualified withdrawals.
Your contributions and account growth for an FSA and HSA are tax-free when you spend them on qualified expenses. For 2022, the maximum HSA contribution is $3,650 for individuals and $7,300 for families. The FSA contribution limit is $2,850.
3. Claiming itemized tax deductions
When you file taxes, you have the option to claim the standard deduction or itemize deductions separately on Schedule A. Itemizing is only worthwhile when your total deductions exceed the standard amount. For 2022, the standard deduction is $12,950 for single taxpayers and $25,900 for married couples filing a joint return.
If you made substantial payments for mortgage interest, property taxes, medical expenses, and local and state taxes, itemizing your deductions might allow you to save money. The allowable deductions get subtracted from your adjusted gross income, reducing your taxable income.
So, be sure to keep records of your deductible expenses so you (or your accountant) can figure out whether claiming the standard deduction or itemizing allows you to avoid paying the most taxes.
4. Qualifying for tax credits
While tax deductions are terrific because they reduce your taxable income, tax credits can be even more valuable. Tax credits reduce the amount of tax you owe or increase your tax refund.
For instance, for 2022, the Earned Income Tax Credit allows low-income taxpayers to claim up to $6,935 for three or more qualifying children, $6,164 for two, $3,733 for one, and $560 for none. The Saver’s Credit also benefits low-income taxpayers who save for retirement by giving them a credit of up to half their contributions.
If you’re a student, there are multiple education tax credits. They include the American Opportunity Tax Credit, which pays up to $2,500 per year for eligible students for the first four years of their higher education. Plus, the Lifetime Learning Credit allows a maximum credit for qualifying expenses up to $2,000.
5. Owning real estate
Not only is real estate about an actual shelter, but it’s also a robust tax shelter. When you own a home, you avoid taxes the year you buy it, every year you own it, and when you sell it.
For instance, mortgage points paid on a home loan, private mortgage insurance, property taxes, and a limited amount of mortgage interest are deductible when you itemize deductions. And if you tap your home’s equity with a loan or a line of credit for renovations or home improvement, you can deduct some of the interest paid.
If you sell your home after living there for at least two of the five previous years, you avoid paying capital gains tax on $250,000 of profit or $500,000 if you’re married and file jointly. Plus, your selling costs, such as real estate commissions, advertising, and title insurance, get deducted from your capital gain.
6. Getting workplace benefits
Many people are unaware that employer-provided benefits, such as health, life, and disability insurance, get deducted from your paycheck before payroll taxes get deducted. Also, fringe benefits paid by an employer, such as education expenses, commuting costs, or a monthly car allowance, typically aren’t taxed.
7. Starting a business
In addition to creating extra income, starting a part- or full-time business offers many ways to avoid paying tax. That’s because many business expenses—such as marketing, supplies, equipment, and professional services—can be deducted from your income, reducing the amount of tax owed.
You’re entitled to even more money-saving tax deductions if you operate your business from a qualifying home office. You’re allowed to deduct a certain amount of household expenses, such as maintenance, insurance, and utilities, based on the size of your office as a percentage of your home. And by the way, home office deductions aren’t just for homeowners—tenants can also claim them.
This article by Laura Adams was originally published on Quick and Dirty Tips.
Published by Debt.com, LLC