Although each person's tax situation is unique, there are several strategies that most taxpayers can use to reduce their taxable income. Here are seven valuable tips from TurboTax Live tax experts to help you minimize your tax bill.
1.Maximize Tax Credits
It's important to claim all the tax credits you're eligible for, as they can have a bigger impact than deductions. While deductions reduce your taxable income, tax credits directly lower the amount of tax you owe.
For instance, if you have a taxable income of $50,000 and take $10,000 in deductions, your taxable income is reduced to $40,000:
- $50,000 taxable income - $10,000 tax deductions = $40,000 taxable income
In your tax bracket, the $10,000 deduction would save you 12%, or $1,200:
- $10,000 taxable income x .12 tax rate = $1,200
On the other hand, a $10,000 tax credit would reduce your tax bill by the full $10,000, offering much greater savings.
2.Save for retirement
Contributions to an Individual Retirement Account (IRA) can be a great way to lower your tax bill. The two most popular IRAs are Traditional and Roth, and the difference between them is when your contributions are taxed.
- Company sponsored 401(k) plans are the most popular option, since many employers often match employee contributions to their 401(k) plans. Experts recommend contributing either the full amount allowed annually ($22,500 for 2023 or $30,000 for taxpayers 50 and over), or - at least - the maximum amount that will be matched by your employer. For 2024, these amounts increase to $23,000 and $30,500 for taxpayers over 50.
- Traditional IRAs are usually pre-tax contributions, meaning your contributions are placed in your IRA before being taxed, lowering your taxable income for the current tax year. You won't pay taxes on your contributions until you withdrawal the money.
- Roth IRAs are taxed upfront. So, although these contributions don’t lower your tax bill in the present, the distributions you take when you retire, including earnings, are tax-free.
3.Contribute to your HSA
Pre-tax contributions to Health Savings Accounts (HSA’s) also reduce your taxable income. The IRS allows you to make HSA contributions until the tax deadline and apply the deductions to the current tax year. This means you can continue lowering your tax bill, even after December 31.
4.Setup a college savings fund for your kids
Initially created to help families save for college costs, 529 plans were expanded by the 2017 Tax Cuts and Jobs Act to include K-12 education at public, private, and religious schools. You can use up to $10,000 annually per student from 529 plan funds for qualifying educational expenses.
- The contributions you make to a 529 plan are not tax-deductible at the federal level, but part or all of them may be tax-deductible at the state level (the rules vary by state).
- The earnings from a 529 account are not subject to federal tax, and the distributions are not taxed as long as they are used to pay for qualified educational expenses for the student named as the beneficiary of the plan.
- Another option under the 529 program is use a pre-paid college tuition plan for a qualified in-state public institution. This allows you to lock in current tuition rates no matter how old your child is.
5.Make charitable contributions
Making charitable contributions is another great way to reduce your tax bill. Donating cash, toys, household items, appreciated stocks and your volunteer efforts to qualifying charitable organizations can provide big tax savings.
- Time spent volunteering isn't tax deductible, but expenses incurred while doing volunteer work may be deductible, such as the cost of ingredients for a donated dish and 14 cents per mile for driving expenses.
- Your donations are only tax deductible if the organization you’re donating to is a qualified nonprofit organization.
- You must itemize your tax deductions in order for charitable contributions to lower your tax bill.
However, for 2020, you can deduct up to $300 in qualified cash contributions per tax return if you take the Standard Deduction. In 2021, this limit increased to $600 for those filing jointly as married and remained at $300 for all other filing statuses.
6.Harvest investment losses
Reporting losses on capital investments can also reduce your tax bill. “Loss harvesting” is considered to be a key year-end strategy. This is when you sell your investments to “realize” a loss (the act of selling at a loss). These losses can be used to offset capital gains taxes, dollar for dollar, reducing your overall tax liability.
- When you have more losses than gains, you can use up to $3,000 of excess losses to offset ordinary income.
- The remainder of the losses (in excess of the $3,000 allowed each year) can be carried forward year after year.
- Keep in mind that the IRS doesn't allow use of losses from a “wash sale"; when you purchase the same or “substantially similar” investment within 30 days before or after the loss.
7.Maximize your business expenses
Usually, business owners and self-employed taxpayers are able to use a much wider range of tax reduction strategies than individual taxpayers because of tax deductible business expenses. Some common business tax deductions include,
- office rent,
- home office expenses,
- the cost of acquiring and maintaining a vehicle for the business, and
- inventory.
Reducing your net profit lowers your self-employment tax, so maximizing your deductible expenses can help reduce your overall tax burden. Claiming business deductions can decrease both your income and self-employment taxes, and you can also deduct a portion of your self-employment tax on your personal tax return.
