The following are some of the basic legitimate strategies to lower your taxes:
1. Earn Tax-Free Income
There are certain incomes that are not subject to income tax, therefore reducing tax liability. Some of the tax-free sources of income include:
- selling a primary home
- opening a health savings account
- depositing money in a tuition plan for your child’s education
- investing in bonds
- certain benefits offered by an employer like health benefits, life insurance, disability insurance, dependent care assistance, and educational assistance.
2. Contribute to a Flexible Spending Account
A tax-free health flexible spending account is another way to reduce taxes. The contributions to such accounts are free from federal or employment taxes.
If an employer participates in a flexible spending account, the employee can choose to contribute an amount to the account at the start of the year. The employer will deduct the payment from the employee’s pay check in the year when the employee contributes, and the employee can collect the maximum reimbursement anytime.
The money on the flexible spending account can be used to reimburse qualified medical expenses incurred within the participating period, and the employer keeps any amount that’s left at the end of the year.
3. Maximize Deductions
Make use of all possible deductions you can claim such as itemized deductions and standard deductions.
Click here to see some of the Tax Deductions for Professionals.
4. Maximize Tax Credits
A tax credit reduces the amount you have to pay in taxes dollar for dollar.
The following are the types of tax credits given by the IRS:
- earned income credit
- retirement savings contributions credit
- first-time homebuyer credit
- adoption credit, education credit
- child and dependent care credit
Note that the IRS adds new tax credits every year, so check with their website to find more information.
5. Contribute to a 401k
Contributions to the 401k go directly from the pre-tax income and deposited into the account. This results in the reduction of the overall taxable income.
6. Donate to Charity
Gifts made to qualified charitable institutions are tax deductible. The donations could be in the form of cash, stock or other certain non-cash contributions.
7. Pay Medical Bills
Medical expenses are the costs incurred for diagnosis, treatment, cure, mitigation, or the prevention of a disease. A taxpayer can deduct medical and dental expenses for themselves, their spouse or their dependents, exceeding the amount equal to 7.5% of their adjusted gross income. Medical expenses are deductible on the year they are paid.
8. Sell Losing Investments
You can turn a loss into a gain by using the losses from the investment to lower tax liabilities. The taxpayer must have taxable gains and losses to qualify for this deduction. If the loss is more than the gain, you can deduct the loss against ordinary income of up to $3,000, or $1,500 for each spouse filing separately. You can carry over additional loss to a later year for those losses that are beyond the limit.
9. Reduce Your Tax Rate
By reducing you tax rate, you can lower your federal income taxes. Rates range from 5% up to 35%. Income earned from work is assessed at an ordinary income rate of up to 35%. While income earned from investments such as mutual funds, stocks, bonds and real estate have lower tax rates.
10. Income Shifting
You also have the option split income or to shift income to a child who is in a lower tax bracket. Splitting income decreases the taxpayer’s adjusted income while at the same time reduces tax liability. However, newer tax laws may make this strategy a little more difficult to use.