You worked a couple of full-time jobs, did not have enough sleep for a year, and then when the tax season comes, the government says: I need to take 35% of your income and you still owe me a few thousand dollars from last year. So, you reached in your pocket and wrote a check to IRS. Are you tired of this game? Did you know that there are ways you can legally pay less tax?
Do you feel like you never get ahead? Even when things are aligned really well, the government crashes you with taxes? You are not alone. There are millions of people who are being crushed by taxes for reasons that could be avoided.
What if you could legally send the IRS a much smaller check? Would you be happy doing it? It is possible to pay less tax without anyone knocking on your door. You just need to know-how. You are competing with a losing hand if you cannot cut down your taxes.
If you are interested in finding ways to pay less tax, you have come to the right place. I want you to succeed and keep the money you make in your pocket. This article will guide you through ways you can use to pay less tax.
Without further ado, the following are 8 ways you can use to pay less tax or at least reduce your taxable income.
1. How to pay less tax: Maximize your 401(k) and 403(b)
One of the most important benefits companies provide to their employees is retirement benefits. Most employees are familiar with 401(k). The 401(K) is a type of profit-sharing plan that employers give to their employees which allows them to save some of their wages toward their retirement, according to the IRS. On the other hand, 403(b) is provided by no-profit organizations and government employers, according to Investopedia. Both 401(K) and 403(b) plans are named after their equivalent sections of the IRS tax code and they offer tax advantages for employees.
Now that we talked about the basics of these plans, you might be wondering how you pay less tax with these plans.
By contributing money to your 401(k) or 403(b), the money that goes into these accounts is pre-tax. The government gives these tax incentives as an encouragement for people to save for their retirements.
How do the government benefits from this deal? The government does not have to take care of old people if they can support themselves. So, everyone wins from this deal.
How much can you contribute to your 401(k)?
If you were wondering, there is a limit to how much you can contribute to your employer-sponsored account. According to SHRM.org, the maximum contribution an individual can contribute to their 401(k) plans for 2021 is $19,500. Those who are over 50 years old can contribute an extra $6,500 to their accounts to catch up.
This amount is great to help you reach your financial independence earlier. In addition, your employer will contribute a limited amount to your account. Some employers can match your contributions 100%. Others can match your contributions up to a given percentage and add more based on your plan and your contributions.
Since your contributions to your 401(k) are tax-free, this reduces your taxable income. For example, if your gross income was $50,000 and your contributed $10,000, your taxable income will be $40,000. Keep in mind that this amount can go lower if you have other tax advantages such as Health Saving Accounts(HSA).
Because your taxable income becomes smaller when you contribute to your 401(k), you end up paying less tax.
2. Take advantage Health Savings Account (HSA) through your employer
This option also has something to do with your job. If your employer offers you health coverage, you could take advantage of HSA benefits. A health savings account lets you put aside pre-taxed money to help you pay qualified medical expenses.
How much can you contribute to your HSA account?
According to healthcare.gov, you can contribute to your HSA account only if you have a High Deductible Health Plan (HDHP). Self-coverage contributions in the HSA are limited to $3,600 for 2021 and $3,650 in 2022. Family coverages with HDHP can contribute to the HSA account up to $7,200 in 2021 and $7,300 for the family.
By putting pre-taxed money into your HSA account, you automatically decrease your taxable income. That is why HSA accounts are very crucial and beneficial for those who want to take control of their finances.
Another great benefit of an HSA account is that you can roll your money into your retirement account or into another HSA account, in case you change employers. According to SmartAsset, you can roll over the money from HSA into your IRA, other retirement accounts, or from one employer to another. Some rules apply to this process and IRS does not allow a direct transfer from HSA to a 401k.
Not only that an HSA account helps you save money on taxes, but it can also help you grow your retirement accounts if you choose this route.
3. How to pay less tax: Claim tax credits and deductions
Tax credits and deductions can help you pay less tax when you are filing. According to IRS, tax credits reduce the amount of tax you owe whereas tax deductions reduce your income before calculating your tax. These two benefits are there to help you keep the money in your pocket.
There are a ton of tax credits that vary from one case to another. For example, you can get tax credits for Child and Dependent Care Expenses. The IRS has a document that helps you check your qualifications and other resources you need for this particular example. Read the pdf document here if you are interested in learning more.
There are many other tax credits you can claim such as homeowner credits, Income and savings credits, health care credits, and education credits. If you want to legally pay less tax, use resources available to you and take advantage of things you qualify for.
4. Lower your tax by starting a business
If you are a business owner, you probably know that you qualify for business credits and tax deductions. According to IRS, your business can have a lot of credits and deductions which include:
- Opportunity Zones
- Plug-In Electric Drive Vehicle Credit (IRC 30D)
- Research Credit
- Deducting Business Expenses
- Abusive Tax Shelters and Transactions
If you own a business, it is possible that your business qualifies for one or more of these deductions.
5. Lower income tax by buying Municipal Bonds
One great way to legally pay less tax is to buy Municipal bongs. These are bonds issued by your state, city, county, or any other government entities in order to finance government projects. These projects include but are not limited to building schools, roads, hospitals, bridges, etc.
By buying municipal bonds, you are lending the government your money. In return, you get a fixed interest paid usually semi-annually. According to Investor.gov, the interest from municipal bonds is exempt from federal income tax. That is right. You will pay no federal income tax on the interest you make from your municipal bonds.
The good news does not end there. According to Merrill Bank Of America, some states also make the interest generated from municipal bonds state income tax-free. If there is a good way to legally pay less tax, is through buying municipal bonds. The government gives tax incentives to people so that they can lend it money. Take advantage of these services and build your wealth one step at a time.
6. How to pay less tax: Buy long term investments
Rich people get away with tax by acquiring long-term investments. So, what is a long-term investment? A long-term investment is nothing other than an investment you keep for a long time. By default, a long-term investment should be kept for at least one year. The longer you keep the investment, the more tax benefits you get.
How does a long-term investment save money in tax?
Before we answer this question, let’s see how these investments work. Let’s say that you bought shares of a company last week and you want to hold it for 10 years.
At the end of 10 years, let’s assume that the share price doubled and you decided to sell. That is you made a 100% return on the money you invested. During the 10 years period, you did not pay capital gain tax on this investment. This is because all the gains you made on your investment were not realized until you decided to sell.
Long term-investments also receive tax benefits through capital gains tax. According to Bankrate, long-term capital gains have much lower tax rates of 0%, 15%, and 20%. These rates depend on tax brackets, marital status, and how long the assets were owned.
This is how the rich keep getting richer. They buy and hold investments for a long time. During the period they are holding their investments, they pay no tax. And when they decide to sell, they pay less tax.
The point here is that by holding an investment for a long time, you delay paying taxes on it. This makes your money grow really fast and gives you a chance to achieve financial independence easily.
7. How to pay less tax: Make less money(a very silly choice)
This one is silly. You can avoid paying taxes by making less money. The question is: Do you need to starve yourself so that you can pay little to no tax? I will let you answer that.
The IRS will not come after you if you made below the minimum taxable income. That is you pretty much made no money at all and the IRS looks at your income and says: If we take anything from that person he/she is going to die. So, you get a free ride.
The minimum taxable income varies based on your filing status and age category. According to H&R Block, individuals filing single do not need to file tax returns if they are under 65 years old and their income is $12,400 or lower. Those who are older than 65 years old and filing single do not need to file tax returns if their income is $14,050Â or under. These statistics apply only to 2020. For more details regarding age categories and minimum taxable income, read the full article from H&R Block.
8. Pay less tax through charitable deductions
Did you know that you can pay less tax by donating your money? According to IRS, cash donations can be deductible as long as they meet requirements. For charitable cash contributions, the donation must meet the IRS requirements.
These requirements are the following: (1) Your charitable contributions must have been made in cash, (2) The cash must have been donated to the right organization, and (3) the contribution should be made in 2020. Limits to how much donations are deductible also apply and they vary from individual to business. You can find more details on the IRS website.
More details on specific cash amounts and what organizations meet the requirements for 2020 are also included.
