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The federal income tax bracket is as high as 37 percent for some people, which, come tax time, can be an unpleasant surprise. While business owners and self-employed taxpayers have the most tax deductions, there are simple steps you can take to reduce your taxable income to pay less taxes.
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Ways to Reduce Your Taxable Income
Contribute to Your 401(k)
If your employer offers a 401(k), take advantage of it, and contribute the amount your employer will match. Because you contribute earnings pre-tax, making these contributions are one of the top ways to reduce your taxable income.
You only pay income taxes on your earnings after deducting your 401(k) contributions from your total earnings. This lowers your tax liability right out of the gate. Rather than paying taxes on your total earnings and getting reimbursed, you’ll pay taxes on some of your earnings, excluding those earnings applied to your 401(k).
Contribute to Your IRA
If you don’t have a 401(k) or if you have more money to contribute to your retirement, contribute earnings to other retirement accounts, like an IRA, to receive a tax break. Unlike 401(k) contributions, you will pay taxes on your total earnings. However, you can write off IRA contributions on your tax returns.
It’s worth noting that this strategy is only effective if you contribute earnings to a traditional IRA. Some taxpayers prefer a Roth IRA which provides tax benefits in retirement, but you make your contribution after taxes.
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Fund Your Flexible Spending Account (FSA)
If your employer offers an FSA, take advantage of it. In 2021, you can contribute up to $2,750 for the year. Like 401(k) contributions, FSA contributions are made before your employer takes out taxes, making them a great strategy for reducing your taxable income.
You can use your FSA funds to cover medical and dental expenses, including over-the-counter medications and supplies. Most employers require you to use the funds within the year you contribute, but check with your employer to see if they allow your funds to carryover.
Fund Your Health Savings Account (HSA)
If you have a health insurance policy with a high deductible, you can fund an HSA. You can contribute up to $3,600 if you’re only insuring yourself or up to $7,200 if you’re insuring your family. Like a 401(k) and FSA, you contribute funds from your earnings before your employer takes out taxes.
You can use HSA funds to pay medical expenses, including your deductible, premiums, or out-of-pocket expenses.
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Start a Side Hustle
Another strategy to pay less taxes is starting a side hustle so you can write off your expenses. A few common expenses you can write off when you’re a business owner or self-employed are vehicle mileage, marketing fees, website fees, office supplies, and other business-related travel. If you have enough expenses to claim a loss on your business, you can further reduce your taxable income even more. Just make sure that you are eligible to start a business or 1099 position as an immigrant.
Write Off Student Loan Payments
If you're like 65 percent of graduating seniors, you have student loans to pay off. While you can defer them and get payment assistance, eventually you will have to pay them. When you do, you may be able to deduct the interest paid up to $2,500, potentially knocking you down to one of the lower tax brackets and saving you even more money.
You can apply this tax deduction as long as your AGI is less than $70,000 as a single-filer or $140,000 as married filing jointly. If your AGI exceeds these limits, the IRS reduces the amount you can deduct.
Give to Charity
Whether you donate money or goods, you can make charitable deductions to pay less taxes. No matter what you donate, make sure you get a receipt and that it's to a recognized charity or nonprofit organization.
Use Tax Loss Harvesting to Get Your Tax Liability to Zero
Capital gains can cost a lot in taxes, greatly reducing your earnings. Instead, use tax loss harvesting strategies, which involves selling other assets at a loss to offset your gains. Be sure to choose investments you no longer want or don't think is helping your portfolio. Don't just sell for the sole purpose of offsetting taxes without thinking about the bigger picture. You might regret the decision in the future if it was an investment you may not have been ready to part with.
Write Off Real Estate Investor Expenses
Real estate investing includes many applicable tax deductions, including mortgage interest, property taxes, property depreciation, and any other incurred business expenses. Take advantage of these real estate investor expenses to decrease your tax burden.
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Determine if You Qualify for the Earned Income Tax Credit
If you made less than $57,000 in a year, you may be eligible for the Earned Income Tax Credit. In 2020, this tax credit is worth up to $7,000. It's a complicated calculation, and the exact amount you may receive depends on your marital status and number of dependents.
Let a Professional Prepare Your Taxes
No matter how well you know the tax code or how confident you feel about executing strategies to pay less taxes, there’s no comparison to the benefits of using a professional tax service. Let the experts look over your tax returns, determine how to put you into a lower tax bracket, and even help you with tax planning for the future.
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How to Pay Less Taxes FAQ
How Can I Avoid Paying More Taxes?
Use as many tax strategies you can to reduce your taxable income. Look at all possibilities, from deductions for your primary residence, retirement accounts, tax-advantaged accounts, offsetting capital gains, and investing in real estate. Write off all expenses for businesses, and take any tax credits you qualify for.
Who Pays the Least Amount of Taxes?
The Tax Cuts and Jobs Act increased the number of people who don't have to pay taxes at all, with as many as 32 percent of tax returns having no tax liability. The TCJA increased standard deductions and made tax credits easier to obtain to reduce tax liabilities.
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When Do You Have to Pay Taxes?
All taxpayers must pay their taxes by April 15th of each year, but it's the law to pay taxes as you earn money. If you work for someone, they'll deduct taxes from your paycheck each pay period. If you work for yourself, it's your responsibility to file and pay your taxes on a quarterly basis.
Is Any Portion of Your Total Gross Annual Income Non-Taxable?
Taxable income is the money you owe taxes on after any deductions (either standard or itemized). You don't pay taxes on your gross annual income, but only on the earnings left after any legal deductions.
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What Type of Tax Do Most Americans Pay?
Americans pay income taxes and payroll taxes. Your payroll taxes cover things like Medicare, Social Security, and unemployment benefits. All Americans pay both types of taxes and if you are self-employed, you pay both sides of the taxes (employee and employer taxes).
What Is Tax Liability Zero?
Tax liability zero means you either didn't earn enough money to require you to file a tax return or your deductions and credits were enough to bring your tax liability down to zero, meaning you owe nothing for taxes.
How Much Money Do You Have to Make to Not Pay Taxes?
The figure changes every year and depends on a variety of factors. including your age, filing status, number of dependents, and your gross income. In 2020, if you're under the age of 65, you don't need to file a tax return if you make under $12,200. If you're over age 65, that amount increases to $13,600. Check out this IRS quiz to determine if you need to file a tax return.
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Why Do I Owe Taxes This Year and Not Last Year?
Each year may be different. Your tax liability depends on your earned income, passive income, tax bracket, deductions, and tax credits. Some years you may not owe much, and, other years—if you made more money or had fewer write-offs—you may owe more than ever.
How Can I Avoid Paying Taxes on Social Security?
One of the few ways to avoid paying taxes on Social Security is to have little income from your retirement plans. The more money you earn in retirement, the higher your tax bracket becomes. However, most people can't fund their retirement on Social Security income alone, so it takes careful tax planning to avoid paying taxes on Social Security.
Knowing How to Pay Less Taxes Puts More Money in Your Pocket
Everyone would prefer to keep the majority of their earnings and hand less over to Uncle Sam. Knowing how and executing strategies to pay less taxes is complicated, though. With the help of tax professionals, you can maximize your earnings and minimize your tax liability, keeping more of your hard-earned money in your pocket.