How To Pay Less Taxes (Legally)
Dear Rich Lifer,
Tax season is in full swing, and with the filing deadline a little over a month away, we wanted to share with you some ways to pay less in taxes — totally legally.
The current federal income tax brackets range from 10% to 37%, but you can find a way to pay less in taxes if you know how to claim deductions and make use of tax credits.
Luke Sotir, a financial professional with Equitable Advisors, notes that this is usually easier for “self-employed workers and business owners,” but there are several ways for wage earners to also lower their taxes.
Tax credits and deductions do change somewhat frequently. The 2017 Tax Cuts and Jobs Act eliminated some popular deductions and limited others. However, it also increased standard deductions.
Today we will explore eight ways you can reduce what you owe for the 2020 tax season.
Contribute To A Retirement Account
Contributions to retirement funds are one the best and easiest ways to reduce your taxes.
When you contribute to a 401(k) or a Traditional IRA account, you can deduct the amount of your contribution from your taxable income, thus lowering the amount of federal taxes you will owe.
The funds in these accounts also continue to grow, tax-free, until your retirement. Contributions toward a 401(k) must be made by the end of the calendar year, so if you haven’t by now, it is unfortunately too late. However, tax-deductible contributions to traditional IRAs can be made until April 15.
Remember, you cannot deduct contributions to a Roth IRA, and the maximum contribution to a Traditional IRA for the 2021 tax year is $6,000 (if you are over 50, you can contribute $7,000)
Open a Health Savings Account (HSA)
If you have an eligible, high-deductible medical plan, it’s smart to contribute to an HSA. Such contributions offer an immediate tax deduction, grow tax-deferred and can be withdrawn tax-free for qualified medical expenses.
Further, any money left in an HSA at the end of the year will roll over indefinitely. Contributions for 2020 can be made up to $3,600 for individuals and $7,200 for families.
You can also consider a flexible spending account (FSA), which allows you to reduce taxable income by setting aside a portion of your earnings in a separate account managed by an employer. An employee can contribute up to $2,750 during the 2021 plan year; however, contributions do not roll over usually (some new guidances allow employers more flexibility with FSAs due to coronavirus — check with your HR for full details).
Claim Business Deductions
If you are self-employed (either full or part-time) you are eligible for many tax deductions.
Things such as business-related vehicle mileage, shipping, advertising, website fees, professional publications, dues, memberships, business-related travel, and office supplies can qualify deductible from your taxable income.
If you pay for your own health, dental or long-term care insurance, those premiums may be deductible too.
Robbin E. Caruso, a CPA and partner at accounting firm Prager Metis, wants to remind you to keep and maintain proper records. In the case of an audit, you must be able to prove the use of what you are deducting.
A type of business deduction can include…
Home Office Deductions
If you work for yourself or have a side business, you can claim a home office deduction. To qualify for the deduction, the space must be used regularly and exclusively for business purposes.
For example, if you happen to do work-related things at your family’s kitchen table, you cannot claim this as a home office. But, if you have a separate desk just for work, you can claim this space by deducting a portion of your rent and utilities from your taxable income.
You can also deduct…
The government assesses a 15.3% Federal Insurance Contributions Act tax on all earnings to pay for the Social Security and Medicare programs.
Employers split the cost with their workers, so the government allows self-employed people to deduct 50% of the amount paid from their income taxes. You do not need to itemize to claim this tax deduction.
Get Credit for Higher Education
The American Opportunity Credit can cut your tax liability by up to $2,500 if you’re paying for the first four years of higher education for yourself, your spouse or a dependent you claim on your tax return.
This is a credit, which means the amount is deducted from whatever tax you potentially owe the government. If it exceeds the amount of taxes you owe, up to $1,000 may be refundable to you.
To get the full credit, your modified adjusted gross income (MAGI) must be $80,000 or less if single or $160,000 or less for married couples filing jointly.
There is also the Lifetime Learning Credit, which is worth 20% of up to $10,000 in eligible expenses for continued educational classes, even if you aren’t working toward a degree.
There are many other credits non-related to education, including the Earned Income Tax Credit (EITC), which is calculated by considering your family size and income. The EITC is a refundable tax credit for up to $6,600 for 2020 and the income limits for the credit range from $15,820 for single taxpayers with no children to $56,844 for married couples filing jointly who have three or more children.
Itemize State Sales Tax
If you choose to itemize your deductions, you can include either your state income tax or state sales tax on your Schedule A form. The state sales tax break is an amazing option if you live in a state without income taxes.
The federal tax deduction for state and local taxes is capped at $10,000 from all sources.
Charitable contributions made with payroll deductions, checks, cash and donations of goods and clothing are all deductible. You usually need to itemize to claim these deductions, but the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) allows taxpayers who don’t itemize to deduct cash donations of up to $300 made before December 31, 2020.
So you can no longer make qualifying donations, but if you have made them in before the end of 2020, don’t forget to deduct them.
Remember, these are just a few of the many ways you can reduce what you owe in taxes. If you want to learn more, or think you need help making the most of the credits and deductions available, consider consulting with a tax expert.
To a Richer Life,
The Rich Life Roadmap Team