Let’s be honest; we’d all like to pay less taxes each year.
At the same time, we all know that taxes are a part of life. However, there are things you can do to legally reduce the amount of taxes you pay each year.
Taxes are like thunder storms in the tropics. You know they will happen each year, and you know that they can cause some damage. However, if you do certain things in advance to prepare (like building a shelter), you can protect your valuables and minimize any impact that the storm has on your life.
The goal of this page is to provide you with a list of actions you can take today to prepare for the annual tax storm and emerge dry, unscathed, and with your wallet intact.
The more income you make, the more you have to pay in taxes, right?
Well, not necessarily.
If you have a job, contributing to a retirement account is quite possibly the quickest and easiest way to pay less taxes while saving for your future at the same time.
The way it works is simple: you promise to pay taxes on this money in the future, and the government will allow you to deduct the contribution amount from your current gross income.
And… voila! You’ve figured out a way to “lower your income” (and your tax bill) without making less money!
For example, if you are an unmarried person earning a $50,000 salary and contribute $10,000 this year to your retirement account, your Adjusted Gross Income (AGI) drops to $40,000. Since you fall into the 22% IRS tax bracket, your contribution will cut your tax bill by $2,200!
As an added benefit, since your money goes in to your retirement account without being taxed, you can watch your money grow tax-free for years until retirement. Some common retirement accounts that offer this benefit include the following:
Additionally, if you make a low income and still manage to save for retirement, the government will reward your efforts with a Retirement Savings Contributions Credit of up to $2,000. Remember, a tax credit will give you a dollar-for-dollar reduction of your tax bill at the end of the year, which is basically free money.
Contribution limits vary depending on the type of retirement account and tend to change every year or two. In 2020, you can contribute up to $19,500 towards your 401(k) or 457 plans. If you’re age 50 or older, you’re allowed to make “catch up” contributions that bring your total amount to $26,000. Similarly, you can contribute up to $6,000 to a traditional IRA, $7,000 if you’re 50 or older.
Got some expected medical expenses coming up?
Don’t pay full price!
When you contribute to a healthcare savings account, not only does your money go in to the account tax-free, but it also comes out tax free as well!
This is an AMAZING benefit that everyone should take advantage of if they are able to.
Using this trick would allow you to never pay taxes on any money used for medical expenses again!
Even if you’re relatively healthy and only visit your doctor or a pharmacy once or twice a year, why not plan ahead for these unexpected expenses and save yourself some money while you’re at it?
Common healthcare savings accounts offered by many employers include Health Savings Accounts (HSA) and Flexible Spending Accounts (FSA).
Both HSA and FSA accounts help you to pay less taxes by allowing you to contribute pre-tax dollars from your paycheck as long as you use them for qualified medical expenses.
The main difference between the two is what happens at the end of the year. In an HSA, every dollar you contribute is yours to keep, even if you leave the company. Whereas with an FSA, any remaining funds at the end of the year are forfeited. Therefore, it will take better planning to effectively use of your FSA.
Another difference has to do with the amount of money you can contribute each year. In 2020, you can contribute a maximum of $3,550 to an HSA and $2,750 to an FSA.
Ever wonder why every rich person you know owns multiple properties?
Ever wonder how Donald Trump is still a billionaire even after declaring bankruptcy?
There is a why many massive fortunes were built by real estate investing: minimized risk and huge reward.
The government offers numerous incentives that basically subsidize part of your expenses in owning a home. As an owner, you get to deduct mortgage interest and property tax from your tax returns. As a renter, you only get a place to live.
When you are looking to sell your property, you can do so without ever having to pay any long-term capital gains taxes if you identify a replacement property within 45 days of the sale and then complete a 1031 exchange in 180 days. Essentially you can keep rolling over any gains you made from one house to the next and never pay any tax.
In addition, since everyone needs a place to live, it makes more financial sense to be paying off your own home, rather than paying off your landlord’s home.
Obviously, you need a mortgage in order to take advantage of any of these benefits, so consider owning a piece of property once you have built up your emergency fund.
Interested in learning a new skill?
Or considering going back to school to finish your degree?
You could pay less taxes during tax season if you take advantage of government programs designed to help offset the cost of higher education.
If you are perusing your undergrad degree and enrolled at least half-time, the AOTC will allow you to deduct up to $2,500 per year for the first four years of your studies.
Since it’s a tax credit, it will help you pay less taxes by directly reducing the amount you owe, sometimes even resulting in a tax refund.
The Lifetime Learning Credit is worth up to $2,000 per year and is designed to help adults pay for educational expenses that will improve their job skills.
It works similarly to the AOTC, but its much more flexible in that there is no limit to the number of years you can claim it and you do not necessarily need to be pursuing a four-year degree.
So, you had a great time in college, but now it’s time to get back to the real world, get a job, and start paying off those dreaded student loans.
Let’s be honest, the college life was too good to be true. While transitioning from the college life into working a 9-5 doesn’t sound fun, the Government is at least attempting to help you get on your feet by offering a student loan interest deduction.
Essentially you can deduct up to $2,500 from your federal tax return on student loan interest you paid during the year. This is a huge benefit when you’re just getting started and have to juggle paying rent, bills, student loans, and adapting to your new social life.
Not everyone is allowed to claim this benefit, however. If you make between $70,000 and $85,000, the amount you can claim starts phasing out. Once you make over $85,000, you’re ineligible to claim this deduction.
Assuming you fall into the 22% tax bracket and claim the full $2,500 deduction, you could save $550 at the end of the year.
Don’t forget to keep a tab of the charitable donations you make throughout the year. These costs add up and are often overlooked.
Remember, making a charitable donation doesn’t have to mean parting with your hard-earned cash. Donating clothes and other goods counts too.
Just be sure to save your receipts in order to back up your claims during tax time.
If all of your itemized deductions including charitable donations, mortgage interest, and medical expenses are greater than the standard deduction of $12,200, then it makes sense to itemize and pay less taxes.
Small businesses are the lifeblood of the U.S. economy, so the Government will throw many benefits your way if you work for yourself or run a small business.
Even if you’re selling crafts on Etsy or driving for Uber part-time, you’re eligible to deduct many business-related expenses on your tax return.
Some of the most common deductions include the following:
Yes, even the spare bedroom you’ve dedicated to your home office can be tax deductible.
Just like you would with any charitable donations, be sure to save your receipts so that your claims are not disallowed.
Owing and leasing a rental property is also considered a small business, and accordingly, you are allowed to deduct many of your operating expenses during tax season.
A few of the most common deductions include the following:
Your deductions are subtracted from your rental income resulting in your taxable income for the year. Again, be sure to save all of your receipts for expenses as well as supporting documentation for the rent money you received just in case your tax return is audited by the IRS.
Did you know that Warren Buffett pays a lower tax rate than his secretary?
Yes, a billionaire is allowed to pay less taxes (percentage wise) than his secretary because the majority of his income is in the form of capital gains and dividends.
Passive income from qualified dividends and capital gains for example, is taxed at a lower rate than income earned as part of your salary.
This technique is not only reserved for the rich, however. Anyone can pay less taxes by putting this strategy into practice. While it won’t happen overnight, the sooner you start, the sooner you can take advantage of the benefits of lower tax rates.
When you’re ready to take your tax minimization strategy to the next level, let’s discuss how you can start transitioning your income streams from earned income to passive income.
One day these might replace your day job as your primary source of income, and as an added benefit, they will be taxed at a lower rate than the money your former employer was paying you!
Hopefully some of these suggestions will help you to pay less taxes this year and every year.
If you have any additional ideas on how to pay less taxes, please share your thoughts with the community below.
We’d love to hear from you!