Whether this is your first time filing a tax return or your fiftieth it can still seem like a daunting task, not to mention the unexpected tax bill that can follow shortly after. To avoid that less-than-ideal situation and keep more money in your pocket, here are 10 tips that can help reduce your tax bill this year.
The W-4 form provides information to your employer so that they can determine how much to withhold from your paychecks. This will ensure that the IRS collects federal income tax from you in a timely manner. Not paying enough during the year can result in a tax bill and perhaps a penalty, so you should avoid this. Withholding too much can create a refund when you file your tax return.
A refund sounds nice, but getting one probably means that you could have had more take-home pay with each paycheck. Essentially, you gave the government an interest-free loan. Wouldn’t you rather have had that money to use or invest during the year? The goal is to get as close to a $0 refund as possible.
Remember to update your W-4 when you experience a major personal life change or have a change in income. Life events such as getting a new job, getting married, or having your number of dependents change will likely affect how much you will want to withhold in taxes. Since the amount withheld may be based, in part, on the number of people in your family and is affected by other tax credits, you want to check to make sure that the form and withholding is still appropriate.
An IRA is an Individual Retirement Account which allows you to save money for retirement long-term, but in the short-term an IRA can help reduce your tax burden. The amount of your contribution is deducted from your taxable income, thereby reducing your tax liability. Almost anyone who has earned income can contribute but the amount you can contribute is limited; the annual contribution limit for 2022 is $6,000, or $7,000 if you’re age 50+. Contributions can be made at any time during the tax year and until April 15th the following year. And the best news? Your IRA will grow tax-deferred year after year until you retire.
Much like an IRA, contributing to your employer’s retirement plan provides an easy way to reduce the amount of taxable income to report. The IRS does not tax the amount of money you contribute directly from your paycheck to your 401(k). This means that there is less income to report when you file your tax return. Again, your contributions will grow tax-deferred for years until you need to draw on these funds in retirement.
If you and your family have a high-deductible health care plan it may be beneficial for you to consider contributing to a Health Savings Account (HSA). Contributions made to HSA accounts offer immediate tax deductions and grow tax-deferred. If you are 55 or older you can put an additional $1,000 into your account each year. In addition, the funds can be withdrawn tax-free for qualified medical expenses. Any funds left in the account at the end of the year can be rolled over to the next year indefinitely.
If you don’t have a high-deductible health insurance plan, you can still pay for medical expenses with tax-free dollars if your employer offers flexible spending accounts (FSA).
FSAs use tax-free payroll deductions to fund an account, which can then be used to pay for expenses ranging from insurance copays to dental cleanings to over-the-counter medication. Many employers offer FSAs for both employee health care and dependent care. In both cases, there are limits to how much you can deposit, and money may be forfeited if not used by the end of the year.
By donating stock that has appreciated for more than a year, you are actually giving 20% more than if you sold the stock and then made a cash donation. The reason is simple: you avoid capital gains taxes. The maximum federal capital gains tax rate is 20% on long-term holdings. So, if you donate the stock directly to a charity, there’s no capital gains tax to pay. Plus, you are still eligible to deduct the full fair-market value of the asset you donated from your income taxes, up to the overall amount allowed by the IRS.
Making charitable donations can also provide a way to help lower your tax burden. Contributions made with payroll deductions, checks, cash, and even goods and clothing all have the potential to be deducted from your taxable income. When filing taxes, you generally need to itemize in order to claim a deduction.
However, the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, allowed taxpayers who don’t itemize to deduct cash donations of up to $300. This deduction is available again for the 2021 tax year, and married couples filing jointly can deduct a total of $600.
Paying for college is challenging enough, however, the government offers many different tax credits to help offset the expense of higher education. The American opportunity tax credit can be claimed for the first four years of college and provides a maximum credit of $2,500 per student per year. Since it’s a credit, that amount is deducted from whatever tax you might owe.
The earned income tax credit (EITC) is a credit that could give you money back at tax time or help lower the amount of federal taxes you owe at the end of the year. You could receive up to $6,728 dollars from the earned income tax credit. If your credit is more than the amount of federal taxes you owe, you could receive a refund from the government. The EITC is calculated using income and family size. The income limits for the credit range from $21,430 to $57,414 depending on filing status.
Taxpayers who itemize their deductions can include either their state income tax or state sales tax on their Schedule A form. The state sales tax break is a great option if you live in a state without income taxes.
While taxpayers can use a table provided by the IRS to easily claim their sales tax deduction, people should remember to include the sales tax from any major purchase such as a car or boat. The federal tax deduction for state and local taxes is capped at $10,000 from all sources.
Though all these tips may not apply to your situation, they do provide a general overview of the many opportunities to help lower tax debt. Keeping more money in your pocket is always a good thing.