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It seems like no matter which way we turn, we’re getting hit with taxes, right? Federal, state, and local taxes can add up very quickly. Fortunately, there are plenty of easy ways to legally pay less taxes. You just have to know the tax law and what will help you owe Uncle Sam less money.
Here are 5 simple ways to lower your tax liability this tax year.
1. Contribute to your Retirement Account
There are ways to lower your taxes by contributing to your retirement account. If you work for an employer that offers a 401K, this is your best bet since 401Ks have higher contribution limits. If not, or you have more money to save for retirement, you can also open your own IRA (Individual Retirement Account).
Traditional 401K – If your employer matches your 401K contributions, even if it’s only a little bit, take advantage of it! Not only are your contributions pre-tax, but you’ll receive more money for retirement and not pay taxes on it. With an employer-sponsored 401K, you can contribute up to $19,500. If you are over the age of 50, you can contribute an additional $6,500 in catch-up contributions.
Since 401K contributions are pre-tax, if you have a traditional 401K, you pay less taxes today since you’re taxed on a lower amount of income. You’ll see the savings every payday versus waiting until tax time.
Traditional IRA – If you don’t have an employer-sponsored 401K, or if you are looking to put away even more money, you can open your own IRA at any broker. Your contributions are pre-tax if you have a Traditional IRA. Most people can write off up to $6,000 in contributions per year to lower their tax liability.
You’ll claim your contributions when you file your taxes, so it lowers the amount you owe or entitles you to a refund if you overpaid. If you’re over the age of 50, you may also contribute an extra $1,000 in catch-up contributions, for a total of $7,000.
Keep in mind that these limits are as of 2021 and can change every year, so make sure to check the IRS website for the latest figures.
2. Open a Health Savings Account
If you have a qualified high-deductible health insurance plan, you can open a Health Savings Account (HSA). It’s similar to a Traditional 401K since the account is through your employer and is usually pre-tax. However, there are many options outside of what your employers may offer.
If you set your account up with your employer, your employer will withdraw the amount you committed to your HSA before taxes, saving you money on your tax liability. Also, like the 401K, your employer can match a portion of your contributions, which are also tax-free.
In 2021, you may contribute up to $3,600 to an HSA for a single person and $7,200 for a family. This number will increase by $50 and $100 respectively for 2022. Your earnings grow tax-free and if you use the funds for qualified medical expenses, remain tax-free.
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3. Business Tax Deductions
If you own a business or even a side hustle, you can take common business tax deductions to pay fewer taxes.
The most helpful business tax deduction is often the health insurance premium deduction. If you meet the requirements, it can greatly decrease your tax liability. Other common business tax deductions include:
- Rent expenses
- Office and supply expenses
- Equipment depreciation
- Auto expenses
- Business insurance premiums
Remember, even if you run a side hustle, your expenses may help lower your tax liabilities. If you can prove you actively work the business and work it for-profit versus as a hobby, it may be eligible.
4. Hold your Investments Longer
The longer you keep investments, the less taxes you’ll pay on the gains. The IRS threshold is one year. Any investments you buy and sell within the same 12-month period are subject to short-term capital gains tax rates – which are equal to your ordinary tax rates. In other words, you’ll pay the same tax rate on investment returns as you would on money earned from your job.
If you keep the investments for over one year, though, you pay long-term capital gains tax rates. Long-term capital gains tax rates start at 0% and go up to 20% – which is significantly lower than your ordinary tax rates. The amount you pay will depend on your adjusted gross income (AGI).
5. Work with a Tax Professional
Even if you think you know the tax code inside out, it never hurts to work with a tax professional. What if you overlook a major deduction that could lower your tax liability significantly?
Tax laws change each year and sometimes throughout the year. Tax professionals stay on top of the latest legislation and know how to get you the lowest tax bill possible. TurboTax is an affordable service that allows you to speak with tax professionals at the click of a button.
Other perks of using a tax professional include:
- You’ll save the time and headaches involved in filing taxes. Knowing which forms you need, what documents you must provide, and what deductions you can take can have you burning the candle at both ends. Let a professional who does this for a living handle it for you.
- You’ll have less fear of an audit. When a professional does your taxes, you’re less likely to face an audit. You’ll know the tax professional followed the law while getting you every deduction you’re eligible for.
- You’ll get help planning for next year. If your tax liability is higher than you hoped, your tax professional can help you plan for next year, so you don’t have such a high tax bill.
Learning how to legally pay less taxes is one of the most important personal finance subjects everyone should learn. While there are the basic deductions everyone knows about, most people don’t realize they could be saving a lot more money on their taxes.
With a few simple tweaks in your budget or how you file your taxes, you can get major tax write-offs that allow you to have a much lower tax bill. Work with a tax professional today to see how much money you can save this tax year.