Taxes are an inevitable part of life, but that doesn’t mean you can’t take steps to reduce your tax burden legally. While the tax code can be complex, understanding some key tactics can help you minimize the amount of tax you pay and potentially put more money back in your pocket. Here are some strategies to consider:
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First and foremost, stay organized throughout the year. Keep meticulous records of your income, expenses, and potential deductions. Come tax time, you’ll be ready to file accurately and efficiently, and you may uncover opportunities to lower your tax liability. This includes maintaining a filing system for physical and digital documents, such as receipts, invoices, and bank statements. The better organized you are, the easier it will be to support any deductions or credits you claim.
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Maximize your retirement savings by contributing to tax-advantaged accounts, such as a 401(k) or traditional IRA. These contributions are often made pre-tax, reducing your taxable income for the year. For example, if you contribute $5,000 to your 401(k), and you fall into the 22% tax bracket, you could reduce your tax liability by $1,100. It’s a great way to save for the future while also lowering your taxes.
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Take advantage of tax credits, which directly reduce the amount of tax you owe, dollar for dollar. For example, the Child Tax Credit can be worth up to $3,600 per child under age 6 and $3,000 per child ages 6 to 17 for the 2022 tax year. Other credits to explore include the Lifetime Learning Credit for education expenses and the Saver’s Credit for retirement savings contributions. Tax credits can provide significant savings, so be sure to review the eligibility requirements.
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Itemize your deductions if they exceed the standard deduction for your filing status. This tactic is especially useful if you’ve experienced significant expenses in certain categories, such as medical costs, state and local taxes, charitable donations, or mortgage interest. For example, if you had major medical expenses that exceeded 7.5% of your adjusted gross income, you could deduct the excess amount.
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Speaking of deductions, don’t overlook above-the-line deductions, also known as adjustments to income. These reduce your taxable income even if you don’t itemize, and they include a variety of expenses, such as student loan interest, health savings account contributions, and self-employed health insurance premiums. Each above-the-line deduction has specific rules, so be sure to review the requirements to determine your eligibility.
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If you’re self-employed or have side income, consider setting up a solo 401(k) or a SEP IRA. These retirement plans are designed for the self-employed and small business owners, offering tax-deductible contributions and the potential for substantial savings. For example, with a solo 401(k), you can contribute both as an employee and an employer, maximizing your retirement savings and reducing your tax burden.
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Strategically time certain expenses and investments to maximize their tax benefits. For example, if you’re planning to make a charitable donation, consider bunching multiple years’ worth of donations into one year to itemize and get a larger deduction, then take the standard deduction in the other years. Similarly, if you’re expecting a large capital gain, you might offset it with a capital loss in the same year to reduce your taxable income.
These tactics provide a starting point for legally minimizing your tax burden. Every individual’s situation is unique, so be sure to consult a tax professional who can provide personalized advice and ensure you’re taking advantage of the most applicable strategies while remaining compliant with the tax code.
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Another strategy is to consider income-shifting strategies, especially if you’re self-employed or have control over the timing of your income. You might defer invoicing clients until January to push that income into the next tax year, giving you more time to save for the associated tax liability. Similarly, if you expect to be in a lower tax bracket next year, you could accelerate expenses or deductions into the current year to get more bang for your buck.
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Take advantage of tax-loss harvesting if you invest in the stock market. This strategy involves selling securities at a loss to offset capital gains that would otherwise be taxable. You can use these losses to reduce your taxable income by up to $3,000 per year, with the ability to carry forward any excess losses to future tax years. Just be mindful of the wash-sale rule, which prohibits buying the same or substantially identical security within 30 days of selling it at a loss.
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Don’t forget about dependent care benefits if you have children or other qualifying individuals in your care. You may be able to exclude from taxes up to $5,000 of employer-provided dependent care assistance benefits that you use for expenses like preschool, summer day camp, or a nanny. This benefit is typically offered through a flexible spending account (FSA), and it can provide valuable tax savings while helping to cover the costs of caring for your loved ones.
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Self-employed individuals and business owners can benefit from a range of tax deductions, including home office expenses. If you use part of your home exclusively and regularly for business, you may be able to deduct a portion of your rent or mortgage interest, utilities, insurance, and repairs. This deduction can lower your taxable business income, resulting in significant tax savings, especially if your home office makes up a substantial portion of your workspace.
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Explore the Qualified Business Income (QBI) deduction if you own a pass-through entity, such as a sole proprietorship, partnership, or S corporation. This deduction allows you to deduct up to 20% of your qualified business income, effectively lowering your tax liability. There are specific criteria to meet, including income thresholds and the type of business you operate, so be sure to review the rules carefully. This deduction was introduced as part of the Tax Cuts and Jobs Act and can provide a valuable benefit to small business owners.
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If you’re self-employed, don’t forget about the self-employment tax deduction. While it doesn’t reduce your income tax liability, it can lower the amount of Social Security and Medicare taxes you owe. You can deduct the employer-equivalent portion of your self-employment tax, which is half of the total, resulting in a significant reduction in your taxable business income. This deduction is taken directly on your tax return and is a valuable perk for those who are their own bosses.
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Business owners can also benefit from expensing their business assets, which allows them to recover the costs of acquiring or producing these assets more quickly. Section 179 of the tax code permits the immediate deduction of the full purchase price of qualifying equipment or software, up to a certain limit. Alternatively, bonus depreciation allows you to deduct a percentage of the asset’s cost in the first year, with the remaining cost depreciated over time. These strategies can provide substantial tax savings in the year of purchase.
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If you’re an investor, be mindful of your investment expenses. You may be able to deduct certain costs associated with producing or collecting taxable investment income, such as advisory fees, safe deposit box fees, and subscription fees for investment services. These expenses are typically itemized and must exceed 2% of your adjusted gross income to be deductible. Keeping track of these expenses can help you reduce your overall tax burden, especially if you have a sizable investment portfolio.
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Consider the tax benefits of moving if you’re planning a relocation. Certain moving expenses may be deductible if your move is job-related and meets distance and time worked tests. This could include the cost of packing and transporting your household goods and even the cost of transporting yourself and your family to your new home. Additionally, if you’re moving to a state with lower income taxes, you could benefit from a reduced tax burden on your overall income.
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Lastly, stay informed about tax law changes and upcoming legislation. Tax laws can change from year to year, and being aware of these changes will help you make informed decisions. For example, the Tax Cuts and Jobs Act doubled the standard deduction and eliminated some itemized deductions for tax years 2018 through 2025. Staying abreast of these updates will help you choose the best tactics for your situation and ensure you don’t miss out on valuable tax-saving opportunities.
Remember, while these strategies can help minimize your tax burden, seeking personalized advice from a tax professional is always recommended. They can help you navigate the complexities of the tax code and ensure you’re taking advantage of every legal tactic to lower your tax bill.