Ever wonder to yourself, “How can I pay less in taxes?”
Me too!
Well, last year, my neighbor, Dave, a regular guy with a 9-5 job, slashed his tax bill by a whopping 30%.
“How can I pay less in taxes, too?”
That’s exactly what I decided to find out.
As someone who’s always hunting for the next great money hack, I knew I needed the inside scoop.
So, I contacted a tax accountant and CPA known for turning tax jargon into savings gold.
During our chat, this tax whiz laid out some of the most surprisingly simple yet effective strategies to keep more of your money away from Uncle Sam.
And guess what?
I’m about to share these gems with you.
Whether you’re in the prime of your career or enjoying your retirement years, these expert tips – legal and ethical, mind you – will change your financial game.
Let’s uncover these tax secrets together and see how we can all follow in Dave’s footsteps!
How To Pay Less In Taxes
Here are 6 expertly curated ways that can help you pay less in taxes.
1. Maximize Retirement Contributions
Contributing to retirement accounts like 401(k)s or traditional IRAs reduces your taxable income because the contributions are made pre-tax.
Let’s consider an example of how contributing to a 401(k) can affect someone’s taxes. We’ll look at two individuals, Alex and Taylor, both earning $60,000 a year. Alex contributes to a 401(k), while Taylor does not.
Example:
- Annual Income for Both: $60,000
- Federal Income Tax Rate: Assume they both fall into a 12% straight tax bracket for simplicity.
- 401(k) Contribution (Alex): $6,000 per year (10% of income)
- No 401(k) Contribution (Taylor): $0
Scenario 1: Alex Contributes to a 401(k)
- Adjusted Gross Income (AGI): $60,000 – $6,000 (401(k) contribution) = $54,000
- Federal Income Tax (12% Bracket): 12% of $54,000 = $6,480
Scenario 2: Taylor Does Not Contribute to a 401(k)
- Adjusted Gross Income (AGI): $60,000 (no 401(k) contribution)
- Federal Income Tax (12% Bracket): 12% of $60,000 = $7,200
Comparison:
- Alex’s Tax: $6,480
- Taylor’s Tax: $7,200
- Difference: Taylor pays $720 more in federal income tax than Alex.
In this example, by contributing $6,000 to their 401(k), Alex saves for retirement and reduces his taxable income, resulting in a lower tax bill. In essence, Alex’s $6,000 investment in their future has effectively “cost” him only $5,280 after considering the tax savings ($6,000 – $720).
Key Takeaways to Help You Pay Less in Taxes:
- Lower Taxable Income: Contributions to a traditional 401(k) are made with pre-tax dollars, which lowers your taxable income.
- Immediate Tax Benefit: The tax savings are immediate, as seen in the current year’s tax bill.
- Long-Term Savings: Apart from immediate tax benefits, the individual also boosts their retirement savings, which grow tax-deferred.
Note: This is a highly simplified example as it doesn’t take any other credits or deductions into account, and it is using a straight tax instead of a progressive tax (learn more about the difference here), but the moral of the example remains: contributing to a retirement account like a 401(k) can reduce your taxable income thus decreasing your tax liability.
2. Utilize Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs)
HSAs are available to those with high-deductible health plans. Contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free. FSAs are offered by employers on non-high-deductible health plans and allow for pre-tax contributions to cover medical expenses, effectively reducing taxable income.
Let’s consider an example of the tax impact of contributing to a Health Savings Account (HSA) versus not contributing. We’ll use two individuals, Jordan and Casey, who have similar financial situations but differ in their approach to using an HSA.
Example:
- Annual Income for Both: $50,000
- Federal Income Tax Rate: Assume they both fall into a 12% straight tax bracket for simplicity.
- HSA Contribution (Jordan): $3,000 per year
- No HSA Contribution (Casey): $0
Scenario 1: Jordan Contributes to an HSA
- Adjusted Gross Income (AGI): $50,000 – $3,000 (HSA contribution) = $47,000
- Federal Income Tax (12% Bracket): 12% of $47,000 = $5,640
Scenario 2: Casey Does Not Contribute to an HSA
- Adjusted Gross Income (AGI): $50,000 (no HSA contribution)
- Federal Income Tax (12% Bracket): 12% of $50,000 = $6,000
Comparison:
- Jordan’s Tax: $5,640
- Casey’s Tax: $6,000
- Difference: Casey pays $360 more in federal income tax than Jordan.
In this example, Jordan contributes $3,000 to her HSA, which reduces her taxable income, resulting in a lower tax bill. The $3,000 invested in the HSA for future medical expenses has effectively “cost” Jordan only $2,640 after considering the tax savings ($3,000 – $360).
Key Takeaways to Help You Pay Less in Taxes:
- Lower Taxable Income: Contributions to an HSA are made with pre-tax dollars, which lowers your taxable income.
- Immediate Tax Benefit: The tax savings are immediate, as seen in the current year’s tax bill.
- Healthcare Savings: Apart from tax benefits, the individual also accumulates funds for future medical expenses, which can be withdrawn tax-free for qualified medical expenses.
3. Take Advantage of Tax Credits
Tax credits provide a dollar-for-dollar reduction in your tax bill. Here are some tax credits you should be aware of:
Child Tax Credit
- Beneficiaries: Parents or guardians with qualifying children under the age of 17.
- Details: Provides a credit for each qualifying child to offset the costs of raising children.
Earned Income Tax Credit (EITC)
- Beneficiaries: Low- to moderate-income working individuals and families, especially those with children.
- Details: A refundable credit that increases with the number of qualifying children.
American Opportunity Tax Credit (AOTC)
- Beneficiaries: Students in their first four years of higher education (college or university) and their parents if they are claimed as dependents.
- Details: Covers expenses like tuition, course materials, and certain fees, partially refundable.
Lifetime Learning Credit
- Beneficiaries: Students pursuing post-secondary education (including courses to acquire or improve job skills) and their parents if they are claimed as dependents.
- Details: Offers a credit for tuition and related expenses, available for an unlimited number of years.
Child and Dependent Care Credit
- Beneficiaries: Taxpayers who pay for childcare or dependent care while working or looking for work.
- Details: Provides a credit based on a percentage of the amount paid to a caregiver for children under 13 or a disabled dependent.
Adoption Credit
- Beneficiaries: Individuals who have incurred expenses while adopting a child.
- Details: Offers a credit for qualified adoption expenses.
Saver’s Credit
- Beneficiaries: Low- to moderate-income individuals who contribute to retirement accounts like IRAs or employer-sponsored plans.
- Details: A non-refundable credit for making eligible contributions to retirement plans.
Residential Energy Efficient Property Credit
- Beneficiaries: Homeowners who install renewable energy sources (solar, wind, geothermal, or fuel-cell technology) in their homes.
- Details: A credit for some of the cost of installing qualifying energy-producing systems.
Foreign Tax Credit
- Beneficiaries: Taxpayers who pay or accrue tax to a foreign country on foreign-sourced income.
- Details: Allows taxpayers to avoid double taxation (paying tax to both the U.S. and the foreign country) on the same income.
Electric Vehicle Tax Credit
- Beneficiaries: Buyers of new qualified plug-in electric vehicles.
- Details: A credit for a portion of the purchase of a new electric vehicle.
4. Itemize Deductions to Pay Less in Taxes
The standard deduction is a fixed dollar amount that reduces your taxable income. It’s available to all taxpayers and varies depending on your filing status (single, married, filing jointly, etc.). For many taxpayers, especially those without significant mortgage interest, state and local taxes, or charitable contributions, the standard deduction offers a simpler and more beneficial way to reduce taxable income.
For 2023, the standard deduction for tax returns filed in 2024 is $13,850 for single filers, $27,700 for joint filers, or $20,800 for heads of household. However, suppose the sum of your itemizable deductions exceeds the standard deduction amount. In that case, you can itemize deductions on your tax return, potentially leading to greater tax savings. Here are key deductions to consider:
Mortgage Interest
If you own a home and are paying off a mortgage, the interest you pay is deductible. This can be significant, especially in the early years of a mortgage when interest makes up a larger portion of each payment.
State and Local Taxes (SALT)
This includes state and local income taxes (or sales taxes if you choose to deduct these instead) and property taxes. There’s a cap on the SALT deduction ($10,000 as of my last update in 2023).
Charitable Contributions
Donations to qualified charities are deductible. This doesn’t just include cash contributions; it can also include property donations, mileage driven for charitable services, and out-of-pocket expenses incurred while doing volunteer work.
Medical and Dental Expenses
You can deduct unreimbursed medical and dental expenses that exceed 7.5% of your adjusted gross income (AGI). These expenses can include payments for doctors, surgeries, medical devices, and some types of health insurance.
Example of Itemizing vs. Standard Deduction:
Imagine a taxpayer, Jamie, who is single and has the following potential deductions:
- Mortgage Interest: $10,000
- State and Local Taxes: $4,000
- Charitable Contributions: $2,000
- Medical Expenses: $3,000 (but only $1,000 exceeds 7.5% of Jamie’s AGI)
Jamie’s total itemizable deductions would be $17,000 ($10,000 + $4,000 + $2,000 + $1,000). If the standard deduction for a single filer is $13,850, Jamie will benefit more from itemizing since $17,000 > $13,850
Key Considerations:
- Comparison is Crucial: It’s essential to calculate both the total of your itemizable deductions and the standard deduction and then choose the option that offers the greater tax benefit.
- Documentation: If you itemize, it’s important to keep thorough records and receipts in case of an IRS audit.
- Tax Law Changes: Be aware of the latest tax laws, as changes can affect the deductibility of certain expenses and the standard deduction amount.
While the standard deduction is sufficient and beneficial for many taxpayers, itemizing deductions can lead to greater tax savings for those with significant deductible expenses. Consulting with a tax professional can help you navigate this decision and maximize your tax savings.
5. Deduct Business Expenses to Pay Less in Taxes
Understanding and capitalizing on the deductions available for business expenses is crucial for reducing taxable income for self-employed individuals. Here’s a more detailed look at some of the key deductible business expenses:
Home Office Expenses
If you use a part of your home regularly and exclusively for business purposes, you may be eligible to deduct expenses related to this portion of your home. This includes a portion of rent or mortgage interest, utilities, property taxes, maintenance, and repairs. There are two methods to calculate this deduction: the simplified option (a standard deduction per square foot of the home office) and the regular method (based on the actual expenses incurred).
Travel Costs
Business-related travel expenses are deductible. This includes airfare, hotel stays, car rentals, and a portion of meal expenses during business trips. If you use your car for business, you can choose to deduct actual expenses or use the standard mileage rate set by the IRS.
Supplies and Equipment
The cost of supplies and equipment necessary for your business operation is deductible. This can include office supplies, computers, software, and any industry-specific tools or materials.
Health Insurance Premiums
Self-employed individuals can deduct 100% of their health insurance premiums for themselves, their spouse, and dependents, provided they are not eligible for coverage through an employer.
Retirement Plan Contributions
Contributions to a self-employed retirement plan, like a SEP IRA or Solo 401(k), are deductible. These plans also allow for higher contribution limits compared to traditional IRAs.
Educational Expenses
Education expenses that maintain or improve skills needed in your current business are deductible. This includes courses, workshops, books, and relevant materials.
Telephone and Internet Costs
If you use your phone and internet for business, a portion of these costs can be deductible, based on the percentage of business use.
Professional Services
Fees for legal, accounting, and other professional services directly related to your business operations are deductible.
Advertising and Marketing
Costs incurred for advertising and marketing your business, including website maintenance, online advertising, and print materials, are deductible.
Bank Fees and Interest
Bank fees and interest on loans taken out for business purposes are deductible.
Rent for Business Property
If you rent an office, storefront, or other space for your business, the rent payments are fully deductible.
Utilities for Business Property
Utilities for a rented business property, like electricity, gas, and water, are fully deductible.
Important Considerations:
- Exclusive and Regular Use: Particularly for home office deductions, the space must be used regularly and exclusively for business purposes.
- Proper Documentation: Keep detailed records and receipts of all business expenses. Accurate record-keeping is essential for substantiating deductions if audited by the IRS.
- Understanding Limits: Some deductions have limits or specific requirements. For example, entertainment expenses are largely non-deductible, and meal expenses are subject to a 50% limit.
Self-employed individuals can significantly reduce their taxable business income by carefully tracking and deducting these expenses, leading to substantial tax savings. It’s always recommended to consult with a tax professional to ensure you maximize your deductions while staying compliant with tax laws.
Don’t have a business? You could always start one knowing that many business expenses are tax deductible!
Learn more:
Side Hustle Ideas: Over 200 Ways to Make Money on the Side
Simple and Legit Way to Make $100 A Day in Passive Income
7 Surprising Simple Steps to Achieve Financial Freedom Now
6. Adjust Your Withholding
Ensuring accurate tax withholding from your paycheck is crucial to managing your finances throughout the year. Wondering how to pay less in taxes in April? It may simply be a matter of adjusting a form in HR to spread it out over the year.
Here’s a more detailed explanation of how this works and why it’s important:
What is Tax Withholding?
Tax withholding is when your employer deducts a portion of your paycheck to pay your taxes directly to the government. The amount withheld is based on your income and the information you provide on your W-4 form.
Why is Correct Withholding Important?
- Avoiding Underpayment: If too little tax is withheld, you could owe a significant amount at tax time, including penalties and interest for underpayment.
- Preventing Overpayment: Conversely, if too much tax is withheld, your paychecks will be smaller, and you’ll essentially give the government an interest-free loan. While you will receive this money back as a tax refund, you could have used it for investments, savings, or other expenses throughout the year.
- Cash Flow Management: Accurate withholding helps you manage your cash flow better throughout the year, ensuring you have more control over your finances.
How to Ensure Correct Withholding:
Here are some steps you can take to make sure your withholdings are correct.
Review and Update Your W-4 Form
The W-4 form you provide to your employer determines how much tax is withheld from your paycheck. It’s important to fill this out accurately and update it when your personal or financial situation changes (e.g., marriage, childbirth, a second job). If you owe a lot every year, you can take the amount you owe, divide it by 12 (because there are 12 months in a year), and ask to have that additional amount taken out of your check every month. This will help you avoid owing a large amount come tax time.
Use the IRS Withholding Estimator
The IRS provides a withholding estimator tool on its website. This tool can help you determine how much tax should be withheld from your paycheck based on your income, deductions, and credits.
Adjust Withholding as Needed
If the estimator or your calculations show that your current withholding is off, submit a new W-4 form to your employer with the correct adjustments.
Consider Additional Withholding
Suppose you have additional income not subject to withholding (like interest, dividends, or self-employment income). In that case, you may need to increase the tax withheld from your paycheck to cover the additional tax liability.
Regular Check-ins
It’s a good practice to check your withholding annually or when there are major life changes. This ensures that you’re not caught off guard at tax time.
Key Takeaways
The goal is to have your withholding closely match your actual tax liability. While a large refund might seem appealing, it means you’ve overpaid throughout the year. Similarly, owing a lot at tax time can be a financial strain.
By carefully managing your tax withholding, you can maintain better control over your finances throughout the year and avoid surprises during tax season.
The Bottom Line: How Can I Pay Less on Taxes?
So, there you have it – a treasure trove of strategies straight from the tax expert’s playbook, designed to help you keep more of your hard-earned money. From maximizing retirement contributions and utilizing health savings accounts, to strategically claiming tax credits and itemizing deductions, the options are plentiful.
Remember, it’s not about finding loopholes; it’s about understanding and leveraging the rules already in place. The aim here is to make the tax system work for you in the most effective way possible. Whether you’re looking to boost your retirement savings, reduce your current tax burden, or plan for future expenses, these strategies can be tailored to fit your unique financial situation.
Like my neighbor Dave, you, too, can achieve significant tax savings with a bit of knowledge and planning. So, take these insights, apply them to your life, and watch as your tax bill potentially shrinks. And remember, when in doubt, consulting with a tax professional can provide personalized guidance to ensure you’re making the most out of these opportunities. Here’s to smarter tax planning and bigger savings for you and your family!
Additional Resources
Want more information to help you prosper? Check out my free weekly newsletter with juicy success hacks and awesome resources related to passive income, personal finance, and positive psychology delivered straight from my brain to yours.
The Friendly Agreement
If you found value in this article, please share it. It takes 10 seconds, and this post took me hours to assemble.
P.S. The information provided on this blog is for educational and entertainment purposes only. It should not be construed as financial advice. The content is not intended to be a substitute for professional financial or tax advice. You should always consult with a qualified financial advisor or tax professional before making any financial decisions. The author and publisher of this blog make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability with respect to the blog or the information, products, services, or related graphics contained.
