Everyone dreads doing their taxes. If you’re at home budgeting, you’re likely looking for a way to cut down your tax bill. Sure, it’s your responsibility to pay your taxes and do so on time. Regardless, you should take advantage of all the provisions within the law that can help you cut down on what you have to pay.
If you’re looking to avoid a surprise once you have to prepare your tax returns, there are several ways to cut your tax bill this year. Here are 5 tips you can do to pay less without evading your taxes.
Take Advantage of Tax Credits
If you’re in a low-income household, the best way to get the most out of your tax planning is to take advantage of tax credits. There are many types of tax credits available, and if you want to cut down your tax bill, it’s vital to get as many of these tax credits within your income bracket as possible.
The earned income tax credit is a powerful way for low-income and middle-income households to get more out of their money. The tax credit, for example, received a temporary expansion once the Build Back Better bill passes.
Single and low-income households, usually those of color and immigrant origin, can benefit EITC. The credit can reduce any federal income tax you owe to the government dollar-for-dollar. EITC can even give you a cash refund if you qualify and eliminate your entire tax bill.
Other tax credits like the Child Tax Credit, Child, and Dependent Care Credit, and American Opportunity Tax Credit can set you up. It’s essential to confirm that you qualify for these credits first. Then again, most of the requirements for each credit are mostly about transparent reporting of your taxes - something you should already do.
Stash Money On Your 401(k) Retirement Account
Here’s a simple money mindset that everyone needs to remember: if you have less taxable income, the fewer taxes you pay. If you want to reduce your tax bill, the most popular way to do so is by pumping some money towards your 401(k). The IRS does not tax anything stashed within your 401(k).
You can use whatever extra you have on your paycheck to add money to your pre-tax 401(k). You can even push the money towards your 403(b) deferrals, with a contribution limit of up to $19,500 for 2021. Investors at ages 50 and older have an additional $6,500 limit on the contributions they can give.
As we said, your contributions are made pretax through paycheck deferrals. This lowers your taxable income and directly cuts your potential tax bill. Remember that 401(k)s are usually employer-sponsored unless you’re self-employed and can freely open your retirement account.
If your company uses an employer-match system, that will be much better. You’re getting free money through your employer. You also need to plan for your 2022 retirement savings, as the limit will jump up to $20,500.
Add Contributions To Your IRA
While we’re still on the topic of retirement accounts, the Individual Retirement Account (IRA) can also help you save up money. The annual contributions to the IRA comes at $6,000 in 2021 and 2022, with catch-up contributions of up to $1000 for those above 50 years old.
Traditional IRA and Roth IRA offer two different contributions and work differently from each other. While both are after-tax contributions, which means you pay taxes on their value, Traditional IRA is tax-deductible during your tax return. Roth IRA does not confer tax deductions, but all withdrawals you do for it will be tax-free.
The IRS has detailed rules on what and how much you can deduct, depending on your income. Several laws have been introduced to affect how contributors can add to their traditional IRA. Several changes now allow those aged 70 ½ years old and older to contribute a maximum of $7000 and receive full tax benefits for it.
Fill Up Your Health Savings Account (HSA)
If a traditional IRA is not up to your tastes from a tax-avoidance perspective, another way to push down your tax bill is to contribute to your health savings account (HSA). HSA contributions are pre-tax, allowing you to contribute until the tax deadline and deduct them from the current tax year.
Your HSA account is also a tax-exempt account, so everything in it is used to pay for any medical expenses that you may have. Withdrawals from your HSA are also free, as long as they are done against qualified medical expenses.
If you have self-only high-deductible health coverage, you have a contribution limit of up to $3600 for 2021. The family high-deductible health coverage can go as much as $7200 in 2021. Those 55 years old and above can put an extra $1000 into their HSA, and you can self-start it too if your employer does not offer it.
Maximize Returns Via Tax-Loss Harvesting
From a simple tax bill perspective, another great way to reduce your tax bill is to sell off investments that declined in value. If you have assets that have losses for the year, you can perform what is known as tax-loss harvesting.
Investment losses are amounts you can write off against your investment gains or other income every year up to a specific limit. The IRS sets the limit at $3000, or $1500 if you’re married filing separately. Any amount that you can’t use for the year also carries on for the following years, reducing your assets for that year.
If you have appreciated assets, it’s best to delay selling them, especially if you don’t have losses to write off against your gains. You should also prefer to pay for long-term capital gains on your investments rather than hefty short-term capital gains.
You should remember that the IRS bans investors from deducting a capital loss against the capital gain of similar security. Known as the wash-sale rule, you can’t gain from the sale of a similar security 30 days before or after.
The Bottom Line
There are many ways to lower your tax bill, from changes in tax credits to funding several pre-tax accounts that can lower your taxable income. There are several ways for you to trim your current tax bill. Taking advantage of these can reduce your tax bill and get you higher gains.
About The Author:
Katreena is a scientist and a life hack specialist. She's authored scientific journals on biotechnology and molecular biology. To take a break from scientific journals, she puts her mind into writing about lifestyle, health, and sustainability. She strongly believes that kindness makes the world go round.