Taxes are inevitable! Like most taxpayers, you are probably wondering how you can minimize the amount you owe. Your income is taxed at the local, state, and federal levels, not forgetting additional deductions to cover Medicare and Social Security. While tax situations differ for every individual, there are specific steps that most taxpayers can take advantage of to lower the tax burden. These steps include but are not limited to:
1. Save for Retirement
One of the simplest ways to minimize your taxes is to save towards retirement. If you work in a company that offers an employer-sponsored plan, you can save up to $19,500 in 2021. Individuals aged 50 years and above can contribute an additional $6,500 above the limit. Since retirement money is saved pre-tax, the contribution is a straightforward way to reduce your tax bill.
However, if you cannot use the employer-sponsored plan, you can save in an individual retirement account. The maximum contribution for an individual retirement account is $6,000 in 2021 and an additional $1,000 for taxpayers aged 50 years and above.
Further, you can deduct all or some of your IRA savings from taxable income if you have an employer-sponsored retirement plan. The IRS has set rules on how much you can deduct, depending on your income.
2. Consider Tax Credits
Taking advantage of tax credits is an excellent way to minimize your taxes. In general, tax credits provide more opportunities for tax relief than tax deductions, as they directly reduce your owed taxes rather than lowering your taxable income. Luckily, Congress has been adding new credits over the years—for example, there are tax credits for home energy improvement, purchasing a hybrid car, and education.
3. Increase Your Tax Deductions
Every individual is entitled to some tax relief. Tax deductions reduce the amount of your income subject to taxation, equaling less taxes paid. This opens the door to strategic tax planning opportunities. For instance, tax deductions can help you save for your kid’s college tuition. You can contribute a maximum of $10,000 per year toward a 529 plan. This contribution is not taxable by the federal government.
You can also make charitable contributions to minimize your tax bill. Donations of clothing, household items, cash, and other charitable gifts are all tax deductible. However, the contributions are only tax-deductible if you donate to a non-profit organization.
Contributing to a Health Savings Account is another way to increase your tax deductions. You can contribute up to $3,600 for an individual and $7,200 dollars for your family in 2021.
4. Be Aware of Your Tax Bracket
Federal tax rates vary; the income tax rate can be as low as 10% for individuals in the lowest tax bracket, and it can be as high as 37% for those earning more. If you make money from long-term investments, such as mutual funds, stocks, real estate, and bonds, the IRS uses long-term capital gains rates to determine your tax bill.
The 2021 long-term capital gains tax rate is 20% for taxpayers in the highest tax brackets. Individuals in the 32%, 22%, and 24% tax brackets are subject to a capital gains tax rate of 15%, while those in the 12% and 10% tax bracket pay zero capital gains tax. It is important to be aware of your tax bracket when planning for tax season. By taking advantage of tax credits, tax deductions, and tax-free investment opportunities, you may be able to lower your taxable income and reduce your taxes owed.
Tax season can be a daunting time, particularly for individuals worried about owing the IRS too much money. Start taking advantage of these tax-saving strategies as soon as possible so you can have an easy time during the tax period.