The tax filing season is a chaotic period for most taxpayers. On top of navigating the confusing tax regulations, parting with your hard-earned money could be a source of significant stress.
Of course, every citizen is responsible for paying their dues without evading what they must rightfully contribute. But what if you’re paying more than you should? This is likely the case for many taxpayers who don’t make enough use of legitimate options available to reduce tax liabilities.
The IRS website provides extensive details on various incentives in place to ease your tax burden. But navigating them could be both overwhelming and time-consuming. So, in this article, we’ve simplified and outlined some of the best strategies you can adopt to re-evaluate your taxable income and manage your financial wealth more prudently.
How to reduce individual taxes legitimately.
Here’s how to reduce taxes owed to IRS using legitimate, IRS-approved tax benefits.
1. Increase your 401(k) contributions
One of the easiest ways to reduce tax liabilities is by contributing to an employer-sponsored 401(k) retirement plan. These don’t just allow you to grow your retirement funds in a tax-free environment. They can also lower your taxable income by a significant amount.
For the 2020 tax year, you can set aside a tax-deductible amount of $19,500 in a (401)k. If you’re 50 and above, it can go up to $26,000. This amount usually increases each year, so you get to save more. And if you’re self-employed, you can opt for a Solo 401(k), which has a tax-deductible contribution limit of up to $57,000 for those aged below 50.
So, what’s the deadline? You can make these contributions any time before the tax filing deadline to reduce tax liabilities.
To find out more about 401(k) savings, click here.
2. Open an IRA
Now, if you’re not part of an employer plan, there are other options to help you lower taxes. One option is a traditional individual retirement account, better known as a traditional IRA.
It allows you to defer taxes until you’re ready to withdraw funds at retirement. This makes it an excellent option to reduce your taxable income.
So, how does it work? Annual contributions you make to a traditional IRA up to $6,000 are tax-deductible. If you’re aged 50 or above, this limit increases to $7,000. And you can contribute to an IRA as long as you wish without any age restrictions.
But to enjoy this tax benefit, you need to meet a few criteria. First of all, your gross income cannot exceed $124,000. You also must not be part of an employer-sponsored retirement plan. This applies to both you and your spouse if you’re filing jointly.
And provided you meet these criteria, you have time till the tax filing deadline to make an IRA contribution and reduce tax liabilities.
To get more information about traditional IRAs, click here.
3. Open an HSA
A Health Savings Account or HSA is another facility available to reduce your taxable income. The funds placed in these accounts are tax-deductible up to $3,550 for those with a high-deductible medical plan. This amount is $7,100 for family coverage, while anyone aged 55 and above can make an extra contribution of $1,000.
Withdrawals from HSAs are also tax-free, provided you use them for a qualified medical expense. And if you don’t withdraw the total contribution, the balance gets carried forward indefinitely.
Now, there are a number of HSA financial institutions that offer Health Savings Accounts. But remember to compare fees, terms, and services before opening one.
To find out more about HSAs, you can visit the IRS website here.
4. Sell underperforming stocks
Selling underperforming stocks in your portfolio could help cut down losses and reduce tax liabilities, too. You can use the loss from the sale to offset your capital gains, which itself will reduce your taxable income.
And if the loss exceeds the total capital gains, then you have a net loss. And it’s deductible from your taxable income up to a $3,000 limit. But you’ll need to ensure that you do not purchase those stocks within 30 days from the date of the sale. If the net loss is more than $3,000, you can even carry it forward to the following year.
If you’re interested in finding out more about this type of deduction, click here.
5. Make a donation
And this applies to contributions made in both cash and goods, including items like clothes and old household appliances. But it remains one of the most overlooked strategies to reduce tax liabilities.
But how much can you deduct? There’s simply no limit to how many donations you can include, as long as you have a valid receipt. But the total dollar amount depends on the type of contribution you make and the charity you choose. You can deduct cash gifts of up to $300 without itemizing. But with itemized deductions, you may even deduct up to 100% of your adjusted gross income based on certain contribution criteria. The IRS also allows carryovers to the next year when the total donations exceed your adjusted gross income.
If you would like more information about charitable deductions, click here.
Use effective tax planning to reduce tax liabilities.
Waiting till the last moment to file your taxes doesn’t just increase room for error. It also doesn’t allow you enough time to make use of effective strategies to lower taxes. So ensure you start early and adopt a more proactive approach by switching to tax planning.
Ideally, tax preparations should start at the beginning of the tax year, not the end. It’ll help you evaluate your taxable income and make efficient use of options available to reduce tax liabilities.
