Safe Strategies: 5 Legal Ways to Reduce Your Tax Obligation
After looking at your online tax return, you may be thinking of ways to reduce your overall tax obligation. Unless you want to risk a lengthy jail sentence, tax evasion isn’t the way to go. Luckily, there are plenty of perfectly legal ways to reduce how much tax you pay each year. Let’s take a look at six such strategies.
1. Contribute to a retirement account
Contributing funds to a retirement account is a common – and highly effective – way to reduce your total amount of taxable income. For US citizens, this usually means funding a traditional 401(k) or IRA account, often with an employer matching the amount you put in. These retirement accounts grow tax-free until you’re ready to use them. Furthermore, some even allow you to withdraw money during retirement without being taxed.
2. Work as a self-employed individual
Whether you work part-time as a ride-share driver or full-time as a freelance writer, there are plenty of tax deductions to enjoy. These include any travel, rent, or equipment expenses related to your business. If you’re required to travel to a work conference, that’s a deduction. If you use a home office, you can deduct that as well. For example, if a ¼ of your living room is regularly and exclusively used to do business, then you can deduct an equivalent amount in rent and utilities. Lastly, if you use a personal computer for business purposes, then you can deduct a portion of it from your taxes.
3. Make charitable donations
When you make donations to qualified charities, your overall tax obligations can be significantly reduced. These donations can include cash as well as household goods such as clothes, books, or electronics that you donate to a local thrift store. When donating, it’s important to write out a list of what you donate to get a better understanding of how much it’s worth. Although rules change from year to year, the IRS allows donations of up to $300 to be deducted without having to itemize the donation. Anything over that requires proper itemizing.
4. Fund an FSA
A Flexible Spending Account (FSA) is a tax-free account that employers can offer to their employees. This account helps you pay for certain medical or dental costs such as copayments, deductibles, prescription medications, diagnostic devices, and even supplies such as bandages and crutches. In 2022, FSA accounts were limited to $2,850 per employee. If you don’t use the money within a year, a portion of it can be rolled over into the next year.
5. Tax Loss Harvesting
Tax-loss harvesting reduces the amount you pay for capital gains. It works by selling off an underperforming asset, using that loss to lower your capital gains taxes, and then offsetting up to $3,000 of ordinary income to reduce the final bill even more. Once that’s done, you take the money from the sale and invest it in another asset – one that’s different enough from the original that it doesn’t violate IRS rules.
6. Time your spending
Although one day may not seem like a big deal, from a tax perspective it is. Paying for something big on the last day of the calendar year versus the first day of the new year has significant tax implications. If you plan ahead and pay for an upcoming mortgage or medical expense in December rather than January, you can deduct some of that expense from your taxes.
Practice the six strategies above to save more and make the tax season less, well, taxing.
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