How to Pay Less Taxes: 9 Simple Steps
Taxes are part of life, but many people would like to know if there are any ways to lower their tax bill.
While paying no taxes isn’t likely, there are ways you can use the tax code to reduce your taxable income and tax liability. These range from knowing the right filing status to maxing out your retirement contributions to understanding which deductions and credits you may qualify for.
Read on to learn some smart strategies for lowering your tax bill without running afoul of the IRS.
Key Points
• Selecting the most appropriate filing status for your situation can lower tax bills.
• Maximizing contributions to retirement accounts can reduce taxable income.
• Withdrawals from a 529 savings plan are tax-free when used for qualifying educational expenses.
• Contributions to a Health Savings Account are tax-deductible, and distributions used for qualifying medical expenses are tax-free.
• With investments, tax-loss harvesting may help reduce the taxes owed on capital gains.
1. Choosing the Right Filing Status
If you’re married, you have a choice to file jointly or separately. In many cases, a married couple will come out ahead by filing taxes jointly.
Typically, this will give them a lower tax rate, and also may help make them eligible for certain tax breaks, such as the Earned Income Tax Credit (EITC), the American Opportunity Tax Credit (AOTC), and the Lifetime Learning Credit (LLC) for education expenses. But there are certain circumstances where couples may be better off filing separately.
Some examples include: when both spouses are high-income earners and earn the same, when one spouse has high medical bills, and if your income determines your student loan payments.
Seeking advice from a tax professional or preparing returns both ways can help you assess the pros and cons of filing jointly or separately.
2. Maxing Out Your Retirement Account
Generally, the lower your income, the lower your taxes. However, you don’t have to actually earn less money to lower your tax bill.
Instead, you can reduce your gross income (which is your income before taxes are taken out) by making contributions to a 401(k) retirement plan, a 403(b) retirement plan, a 457 plan, or an IRA.
The more you contribute to a pre-tax retirement account, the more you can reduce your adjusted gross income (AGI), which is the baseline for calculating your taxable income. A lower taxable income may also put you into different tax brackets. It’s important to keep in mind, however, that there are annual limitations to how much you can put aside into retirement, which depend on your income and your age.
Even if you don’t have access to a retirement plan at work, you may still be able to open and contribute to an IRA. And, you can do this even after the end of the year.
While the tax year ends on December 31st, you may still be able to contribute to your IRA or open up a Roth IRA or traditional IRA (if you meet the eligibility requirements) up until the tax deadline in mid-April.
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3. Adding Up Your Health Care Costs
Health care expenses are typically only deductible once they exceed 7.5% of your AGI (and only for those who itemize their deductions). But with today’s high cost of medical care and, in some cases, insurance companies passing more costs onto consumers, you might be surprised how much you’re actually spending on health care.
In addition to the obvious expenses, like copays and coinsurance, it’s key to also consider things like dental care, prescription medications, prescription eyeglasses, and even the mileage to and from all medical appointments.
4. Saving for Private School and College
If you have children who may attend college in the future, or who attend or will attend private school, it can pay off to open a 529 savings plan.
Even if your children are young, it’s never too early to start setting aside money for their education. In fact, because of the power compounding returns with long-term investing, starting early could help make college a lot more affordable.
A 529 savings plan is a type of investment account designed to help parents save for educational expenses (such as for private schools or colleges) in a tax-advantaged way. While you won’t typically get a federal tax deduction for the money you put into a 529, many states offer a state tax deduction for these contributions.
The big tax advantage is that no matter how much your investments grow between now and when you need the money, you won’t pay taxes on those gains, and any withdrawals you take out to pay for qualified education expenses will be tax-free.
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5. Putting Estimated Tax Payments on Your Calendar
While this move won’t technically lower your taxes, it could help you avoid a higher-than-necessary tax bill at the end of the year.
That’s because income tax in the United States works on a pay-as-you-go system. If you are a salaried employee, the federal government typically collects income taxes throughout the year via payroll taxes.
If you’re self-employed or a freelancer, however, it’s up to you to pay as you go. You can do this by paying the IRS taxes in quarterly installments throughout the year.
If you don’t pay enough, or if you miss a quarterly payment due date, you may have to pay a penalty to the IRS. The penalty amount depends on how late you paid and how much you underpaid.
The deadlines for quarterly estimated tax payments are typically in mid-April, mid-June, mid-September, and mid-January.
For help calculating your estimated payments, individuals can use the Estimated Tax Worksheet from the IRS .
6. Saving Your Donation Receipts
You may be able to claim a deduction for donating to charities that are recognized by the IRS. So it’s a good idea to always get a receipt whenever you give, whether it’s cash, clothing and household items, or your old car.
If your total charitable contributions and other itemized deductions, including unreimbursed medical expenses, mortgage interest, and state and local taxes, are greater than your available standard deduction, you may wind up with a lower tax bill.
Note: For any contribution of $250 or more, you must obtain and keep a record.
7. Adding to Your HSA
If you have a high deductible health plan, you may be eligible for or already have a health savings account (HSA), where you can set aside funds for medical expenses.
HSA contributions are made with pre-tax dollars, so any money you put into an HSA is income the IRS will not be able to tax. And, you can typically add money until mid-April to deduct those contributions on the prior year’s taxes.
Distributions from your HSA are tax-free as long as they’re used for yourself, your spouse, and your dependents for qualifying medical expenses. If you don’t end up needing the money to pay for health care, you can simply leave it in your HSA until you reach age 65, at which point you can withdraw money from an HSA for any reason.
HSAs typically allow you to invest your funds, and in that case, the interest, dividends, and capital gains from an HSA are also nontaxable for qualified distributions.
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8. Making Student Loan Payments
You may be able to lower your tax bill by deducting up to $2,500 of student loan interest paid per year, even if you don’t itemize your deductions.
There are certain income requirements that must be met, however. The deduction is phased out when an individual’s income reaches certain thresholds.
Even so, it’s worth plugging in the numbers to see if you qualify.
9. Selling Off Poorly Performing Investments
If you have investments in your portfolio that have been down for quite some time and aren’t likely to recover, selling them at a loss might benefit you tax-wise.
The reason: You can use these losses to offset capital gains, which are profits earned from selling an investment for more than you purchased it for. If you profited from an investment that you held for one year or less, those gains can be highly taxed by the IRS.
This strategy, known as tax-loss harvesting, needs to be done within the tax year that you owe, and may be used to reduce capital gains on both short-term and long-term investments (short-term gains are taxed at a higher rate than long-term gains). Tax-loss harvesting can help a taxpayer who has made money from investments avoid a large, unexpected tax bill.
The Takeaway
The key to saving on taxes is to get to know the tax code and make sure you’re taking advantage of all the deductions and credits you’re entitled to.
It can also be helpful to look at tax planning as a year-round activity. If you gradually make tax-friendly financial decisions like saving for retirement, college, and health care throughout the year, you could easily reduce your tax burden and potentially score a refund at the end of the year. If you do score a tax refund, you can put it to good use, paying down debt or earning interest in a bank account.
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FAQ
How can I lower my tax payments?
Filing jointly, when applicable, can often get you a lower tax rate and a higher standard deduction. Other common ways to reduce taxes include contributing the maximum amount to retirement accounts, such as 401(k)s and IRAs, making tax-deductible contributions to an HSA account, deducting charitable contributions, and deducting up to $2,500 in student loan interest payments.
With investments, tax-loss harvesting may also help reduce the amount of taxes owed on capital gains.
How can saving for retirement help me lower my taxes?
Contributing to traditional, pre-tax retirement accounts like 401(k)s, 403(b)s, 457 plans, or IRAs can lower your taxable income for the year. These pre-tax contributions reduce the income you report to the IRS, which can result in a smaller tax bill now, while also allowing your retirement investments to grow tax-deferred until retirement.
Are there tax advantages to saving for health care expenses?
Yes, if you have a high-deductible health plan, you may be eligible for a Health Savings Account (HSA). HSAs offer a few different tax advantages: your contributions are tax-deductible, the money, if invested, may grow tax-free, and withdrawals for qualified medical expenses are also tax-free. In addition, non-medical withdrawals made after turning 65 are also tax-free.
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