When it comes to filing taxes, everyone wants to keep as much money in their pockets as possible. The good news is that tax avoidance is a legitimate goal that anyone can achieve. Legally minimizing your taxable income is not just for the ultra-wealthy, as there are plenty of tax-reducing strategies available to people across the financial spectrum.
It’s important to note that tax avoidance is not the same as tax evasion, which is illegal. While it’s illegal to underreport your income to reduce your tax bill, there are many legal avenues to explore. From tax-advantaged retirement savings accounts to favorable deduction opportunities, there are many ways to make the most of your tax refund and leverage the tax system’s benefits to your advantage.
1. Take Advantage of Tax Credits
Tax credits are an effective way to reduce your income tax burden. Every year, the tax code changes, and new deduction opportunities are introduced. Deductions like the Earned Income Tax Credit, deductions for continuing education, consideration for children or other dependents, and many others factor into everyday Americans’ tax preparation strategy year after year.
It’s important to note that you can add one or more deductions to your tax return on top of the standard figure ($13,850 in 2023 for single or married filing separately) to reduce your taxable income. This can significantly lower the amount you should be taxed on and create a yearly return of money. However, it’s worth noting that some tax credits are refundable while others are not. A refundable tax credit may add to your tax return directly while a nonrefundable credit can only lower your calculated taxable income figure.
To take advantage of tax credits, you need to be aware of the available deductions and credits. Some of the most common tax credits include:
- Earned Income Tax Credit (EITC)
- Child Tax Credit
- Education Credits
- Retirement Savings Contributions Credit
- Saver’s Credit
- Residential Energy Credits
Make sure to research and understand the eligibility requirements for each credit and how to claim them. You can also consult with a tax professional or use tax preparation software to help you identify and claim all the credits you’re eligible for.
In summary, tax credits are an excellent way to reduce your income tax burden. By taking advantage of the available deductions and credits, you can lower your taxable income and potentially receive a refund. Make sure to research and understand the eligibility requirements for each credit and how to claim them to maximize your tax savings.
2. Consider Opting for Itemized Deductions
While the standard deduction is the best approach for many taxpayers, opting for itemized deductions can be a more beneficial option for some. Itemized deductions require a bit more effort and calculation to add up everything you can leverage to create a more advantageous tax return. However, it can help you reduce your tax bill by vaulting the total amount you can subtract from your taxable income well beyond the standard rate.
Itemized deductions include things like home mortgage interest, unreimbursed medical expenses, charitable donations, or significant losses due to theft, fire, flood, or similar emergency events. If you have incurred significant out-of-pocket expenses in the past year, an itemized deduction can help dramatically reduce your tax bill.
In 2023, the standard deduction amount for single filers is $13,850, while joint filers can deduct $27,700 without adding up itemized subtractions. Head of household filers will get a $20,800 credit. However, if your out-of-pocket expenses add up to create an itemized figure rising above the threshold that your standard deduction can provide, it’s worth making the extra effort to further minimize your tax burden.
If you are considering opting for itemized deductions, it’s important to keep track of all your expenses throughout the year and ensure that they are eligible for deduction. Additionally, it’s recommended to consult with a tax professional to ensure that you are maximizing your deductions while staying within the legal boundaries.
3. Invest in your IRA or Roth IRA (depending on personal strategy)
When it comes to retirement planning, investing in an Individual Retirement Account (IRA) or a Roth IRA can be a great way to reduce your overall tax burden. Both accounts offer tax-advantaged opportunities to save money for your later years, but they differ in how they provide tax benefits.
A traditional IRA allows you to deposit funds before they are taxed, and the tax bill is levied when you withdraw from the account. This tax-deferred organization can make it easier to contribute a higher amount to your future today. Additionally, tax is assessed on distributions, meaning that you’ll treat withdrawals from the account like a paycheck and can control your tax burden directly since you’re both the payer and payee.
On the other hand, a Roth IRA allows you to withdraw funds tax-free, meaning you’re taxed today on deposits but the account’s growth isn’t. This can be the better choice for many, particularly young savers, as it allows you to earn tax-free growth on your savings.
Deciding which approach might benefit you more depends on your personal strategy. You may opt to use both types of accounts in tandem. Here are some key considerations to keep in mind:
Traditional IRA
- Tax-deferred contributions allow for a higher contribution amount
- Tax is assessed on distributions, allowing for direct control of tax burden
- Ideal for those who expect to be in a lower tax bracket during retirement
Roth IRA
- Tax-free growth on savings
- Tax is assessed on deposits, but not on the account’s growth
- Ideal for young savers or those who expect to be in a higher tax bracket during retirement
Ultimately, investing in either type of account provides a legal and highly effective means of reducing your overall tax burden. It’s important to consider your personal strategy and consult a financial advisor to determine which approach is best for you.
4. Invest in Real Estate Assets
Real estate assets have been a reliable means of holding, growing, and transferring wealth for a long time. Investing in real estate can provide consistent monthly dividends through rent checks. However, rental properties have their own unique volatility that can rival or even surpass that of the stock market.
While it’s unlikely that a rental property will lose substantial value due to competition or brand insolvency, there are other risks to consider. For instance, a renter may choose to stop paying rent or fail to move out at the end of a lease term. Additionally, landlords often need to reinvest in the property to maintain it as a quality living space.
Landlords are responsible for the routine upkeep of the property, such as painting, as well as more substantial, occasional fixes like replacing windows and appliances. Fortunately, these expenses can be funneled through your tax calculation. This is called depreciation and allows you to write off costs associated with owning the asset on your taxes.
Investing in real estate can not only create long-term wealth and short-term cash dividends, but it can also be leveraged to reduce your taxable income. By reducing the amount that Uncle Sam shaves off the top of your paycheck, you can keep more of your hard-earned money.
Consider investing in real estate assets for a reliable means of growing your wealth.
5. Enroll in Collegiate Classes
Enrolling in collegiate classes can not only further your education but also provide significant tax benefits. As a college student, you may be eligible for tax credits that can reduce your tax bill or even result in a refund.
The American Opportunity Tax Credit (AOTC) offers up to $2,500 in tax credit per student on your taxable income with a refundable amount of up to $1,000. This credit is available for the first four years of college for students enrolled at least half-time in a degree or certificate program.
The Lifetime Learning Tax Credit (LLTC) is another option for those pursuing continuing education beyond a four-year degree program. While it isn’t refundable, it offers up to $2,000 in deductions and can be claimed indefinitely as long as you or your dependent are engaged in some form of continuing education.
To be eligible for these tax credits, you must meet certain requirements, including being enrolled at least half-time in a degree or certificate program, not having a felony drug conviction, and meeting income limits.
Enrolling in collegiate classes not only provides you with valuable education and skills but also offers significant tax benefits that can help reduce your financial burden. Be sure to explore all available tax credits and deductions to make the most of your educational investment.
6. Consider creating a business entity to manage your freelance employee income and work
As a freelance employee, you may not have access to the same benefits as traditional employees, but you have the option to leverage your status by creating a business entity to manage your income and work. By opting to be paid through an incorporated company, you gain more control over your income as you approach new tax rate thresholds.
For example, if you are married and filing jointly, there is a significant jump from a 12% to a 22% tax rate when your income hits $94,301. However, by paying yourself just under this number, you can avoid the new tax bracket rate altogether or minimize its impact by deferring some of your income at the end of the year and paying out a higher monthly salary figure in January.
Creating a business entity also allows you to write off business expenses or make purchases using company funds instead of personal ones. This means that if you need to purchase a new computer, you can either write it off as a business expense or buy the computer with company funds. As a freelancer who works from home, there are a wide range of potential business expenses that you can leverage to lower your tax burden and even operate at a legitimate net loss while remaining cash-positive and paying yourself a living salary.
Consider creating a business entity to manage your income and work if you are a freelance employee. Doing so can help you gain more control over your income, minimize the impact of new tax bracket rates, and potentially lower your tax burden by writing off business expenses.
7. Assign Your Assets to an Irrevocable Living Trust
If you’re looking to reduce your tax liability and protect your assets from potential bankruptcy proceedings, an irrevocable living trust may be the legal framework you need. This type of trust account allows you to permanently reassign ownership of assets like investment accounts, real estate holdings, cash, and business assets. While you won’t be able to reclaim these assets as personal property later on, you’ll be able to avoid estate taxes and a potentially lengthy probate process when passing on assets to your loved ones in the future.
Establishing an irrevocable living trust requires a little bit of paperwork and a quality plan. Once your assets are assigned to the trust, they become protected from tax liabilities over the long term. This makes it an excellent means of building a protected portfolio of assets for your loved ones.
It’s important to note that while an irrevocable trust limits what you can do with reallocated assets in the present, it can provide significant benefits over the long term. By placing your assets in this type of trust, you’ll have peace of mind knowing that they’re protected and that you’re taking steps to reduce your tax liability.
Consider speaking with a financial advisor or attorney to determine if an irrevocable living trust is the right choice for your financial goals and needs.
8. Strategize Stock Sales to Avoid Short Term Capital Gains Assessments
When investing in the stock market, it’s important to keep in mind the tax implications of selling your assets. Short-term capital gains taxes can significantly reduce your profits, so it’s essential to strategize your stock sales to avoid these assessments.
Short-term capital gains rates are assessed on any sale involving assets that you’ve held for less than a year. These tax rates can be as high as 37% on a progressive scale, which is equivalent to ordinary income tax considerations. However, if you keep your stocks for longer than a year before selling them, you will be assessed on a much more generous scale that ends at 20%, with most people paying no more than 15% on a portion of their profits.
To avoid short-term capital gains assessments, consider the following strategies:
- Hold on to your stocks for at least a year before selling to take advantage of the more favorable tax rates.
- Sell stocks that have been held for less than a year only if you need to rebalance your portfolio or if you have a significant loss that can offset your gains for tax purposes.
- Consider tax-loss harvesting, which involves selling losing stocks to offset gains in other areas of your portfolio.
By implementing these strategies, you can enjoy a slice of your investment profits without incurring any additional tax liabilities. Remember, proper planning and long-term thinking are crucial when investing in the stock market.
9. Claim Your Dependent Children for a Major Tax Deduction
If you have children, claiming them as dependents can lead to a significant reduction in your overall tax burden. Each dependent child can offer a $2,000 deduction, which can result in a refund of up to $1,400. With some intelligent tax planning, you might be able to boost your refund by over $1,000 per child.
However, it’s important to keep in mind that once your children start working and filing taxes, you will need to revisit their dependent status. A parent cannot claim a child tax deduction on someone who is also filing taxes. As your children approach working age, it will be important for you to have a conversation with them about taxes and the best strategy for reporting income and minimizing the household’s overall tax burden.
For reference, a single person under 65, such as your employed child, must file a return if their gross income is at least $12,950. A teenager working part-time might easily remain under this threshold, potentially delaying that conversation. Nevertheless, it’s worth having the discussion so that everyone knows where they stand.
To summarize, claiming your dependent children can lead to a major tax deduction. However, it’s important to plan ahead and revisit their dependent status as they approach working age. By doing so, you can ensure that your household’s overall tax burden is minimized, and everyone is on the same page when it comes to taxes.
10. Donate Unneeded Goods to Charity
Donating unneeded goods to charity is a great way to get rid of items you no longer need while also supporting a good cause. Charitable donations are tax-deductible, meaning you can reduce your taxable income by the amount of the donation. However, it’s important to keep in mind that charitable donations must be claimed as itemized deductions. This means that you can only deduct the amount of your donations if you choose to itemize your deductions instead of taking the standard deduction.
To ensure that your charitable donations are tax-deductible, you must donate to qualified organizations. These organizations are typically registered as tax-exempt with the IRS and are able to issue tax receipts for donations. When donating non-cash items such as clothing, furniture, or electronics, it’s important to keep in mind that the value of the donation must be properly documented. For donations valued at less than $250, a receipt from the organization is required with a few standard pieces of information included. If a donation exceeds this threshold, you will need a “contemporaneous written acknowledgment” from the organization in question regarding the gift. Additional forms are also required for any donation beyond a $500 valuation.
Donating to charity not only benefits the organization and those in need, but can also benefit you by reducing your taxable income. By donating unneeded goods to charity, you can make a positive impact in your community while also taking advantage of potential tax benefits.
11. Consider Writing a Book About Your Experiences
If you’re looking for a creative way to reduce your tax bill, consider writing a book about your experiences. This strategy worked for one tax filer who spent over a year traveling the world and then wrote a book chronicling his adventure. By selling just 20 copies of the book, he was able to categorize his trip as a business expense and deduct $50,000 from his taxable income.
While this may not be a viable option for everyone, it’s worth considering if you have a unique story to tell. Writing a book can be a time-consuming process, but it can also be a rewarding one. Not only can it potentially reduce your tax bill, but it can also provide a creative outlet and a sense of accomplishment.
Here are some tips to keep in mind if you decide to pursue this strategy:
- Choose a topic that you’re passionate about and that has the potential to appeal to a wide audience.
- Research the publishing process and decide whether you want to self-publish or pursue a traditional publishing route.
- Be prepared to invest time and money into the project, including hiring an editor and cover designer if necessary.
- Market your book through social media, book signings, and other promotional efforts to maximize sales.
By taking the time to document your experiences and share them with others, you may be able to turn your passion into a tax deduction.
