Tax credits and deductions change regularly, and the Tax Cuts and Jobs Act of 2017 eliminated some deductions and limited some others. However, there are still ways for wage earners to lower their tax liability. Currently the federal income tax brackets range from 10% to 37%, but if you’re smart about claiming deductions and credits you can get away with paying less in taxes. Here are 10 steps to help reduce your tax bill.
1- Contribute to your retirement plan
As of 2021, you can place up to $19,500 per year into your retirement account. Contributions to traditional 401(k) and IRA accounts can be deducted from your taxable income and, as a result, reduces the amount of federal tax you owe. Also, employers generally contribute a certain percentage to this money.
Keep in mind, contributions to workplace 401(k) accounts must be made by the end of the calendar year while tax-deductible contributions can be made to traditional IRAs until the tax-filing deadline.
2- Avoid early 401(k) withdraws
Taking loans against your retirement fund leads to charges and penalties. Plus, if you take money out of your 401(k) before the age of 59.5, you will be charged an extra 10% above your income tax. If you leave your 401(k) untouched until retirement, you can lower your tax bill.
3- Open a Health Savings Account (HSA)
An HSA can lower your tax bill if you have a high-deductible healthcare plan. Contributions to these accounts offer an immediate tax deduction, grow tax-deferred and can be withdrawn tax-free for qualified medical expenses. Also, if you have a balance left at the end of the year it can roll over indefinitely.
4- Convert to a Roth IRA
Withdraws from a Roth IRA aren’t counted as income for federal (and usually state) income tax purposes like a traditional IRA. Also, there are no required minimum distributions every year with a Roth IRA, so the money can continue to grow tax-free in the account.
5- Home office deduction
More now than ever, many individuals are working from home. In order to qualify, the office must be used regularly and exclusively for business purposes. So if you have a home office, you can determine what percentage of your living space is used for the office and deduct that from rent and utility fees.
6- Charitable donations
Charitable contributions are all deductible whether they are made by payroll deductions, checks, cash, and/or donation of goods. Also, if you make regular charitable contributions, bundling them could push you above the standard deduction and lower your taxable income. Just be sure to have a receipt for any contributions made to recognized non-profits.
7- Sell losing investments
If you have a losing stock you can sell off stocks for a tax deduction of up to $3,000. This should not be done to avoid taxes, only if you need to. Furthermore, your deduction will be withdrawn by the IRS if you buy back sold stock(s) within 30 days.
8- Avoid Capital Gains Tax by donating stock
You can also use stocks to make charitable gifts to avoid capital gains. If stocks have big gains, you can move them into a donor-advised fund which is not only exempt from capital gains, but can also be deducted if you itemize.
9- Early payments
Some impending expenses can get you a tax deduction, so if possible, pay these prior to December 31st. This could include medical expenses, a mortgage payment, or a charitable donation.
10- Remember state and local tax breaks
The federal tax reform lay eliminated miscellaneous deductions; however, many states still allow them or may lower your threshold for claiming them. For example, New Jersey taxpayers can deduct the cost of medical expenses exceeding 2% of their adjusted gross income. Federal tax forms only allow deductions for medical expenses more than 7.5%.
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