While everyone’s tax situation is different, there are certain steps most taxpayers can take to lower their taxable income. Here are seven great tips from TurboTax Live tax experts to help you lower your tax bill.
The federal tax filing deadline for individuals has been extended to May 17, 2021. Quarterly estimated tax payments are still due on April 15, 2021. For additional questions and the latest information on the tax deadline change, visit our “IRS Announced Federal Tax Filing and Payment Deadline Extension” blog post.
For information on the third coronavirus relief package, please visit our “American Rescue Plan: What Does it Mean for You and a Third Stimulus Check” blog post.
1. Take advantage of tax credits
There are many tax credits available, and it is essential to claim all the benefits you are entitled to. Credits are usually better than deductions because they can reduce the tax you owe, not just your taxable income.
For example, suppose you have $50,000 taxable income and $10,000 in tax deductions. These deductions reduce your taxable income to $40,000.
- $50,000 taxable income - $10,000 tax deductions = $40,000 taxable income
In your tax bracket, that $10,000 of taxable income would have been taxed at a rate of 12%. As a result of your deductions, you would save $1,200 on your tax bill.
- $10,000 taxable income x .12 tax rate = $1,200
Because tax credits reduce the amount of tax you owe, dollar for dollar, $10,000 in tax credits would mean $10,000 in tax savings instead of $1,200.
Some of the most popular tax credits are:
- The Earned Income Tax Credit
- The Child Tax Credit
- The Child and Dependent Care Credit
- The American Opportunity Tax Credit
2. Save for retirement
Contributions to an Individual Retirement Account (IRA) can be a great way to lower your tax bill. The two most popular IRAs are Traditional and Roth, and the difference between them is when your contributions are taxed.
Company sponsored 401(k) plans are the most popular option, since many employers often match employee contributions to their 401(k) plans. Experts recommend contributing either the full amount allowed, annually ($19,500 for 2020 or $26,000 for taxpayers 50 and over), or - at least - the maximum amount that will be matched by your employer.
Traditional IRAs are usually pre-tax contributions, meaning your contributions are placed in your IRA before being taxed, lowering your taxable income for the current tax year. You won't pay taxes on your contributions until you withdrawal the money.
Roth IRAs are taxed upfront. So, although these contributions don’t lower your tax bill in the present, the distributions you take when you retire, including earnings, are tax-free.
3. Contribute to your HSA
Pre-tax contributions to Health Savings Accounts (HSA’s) also reduce your taxable income. The IRS allows you to make HSA contributions until the tax deadline and apply the deductions to the current tax year. This means you can continue lowering your tax bill, even after December 31.
4. Setup a college savings fund for your kids
Originally created to help families save for college tuition, 529 plans were expanded by the Tax Cuts and Jobs Act of 2017 to cover savings for K-12 public, private, and religious school tuition. You can use up to $10,000 of 529 plan funds per year, per student, to pay qualified educational expenses.
- The contributions you make to a 529 plan are not tax-deductible at the federal level, but part or all of them may be tax-deductible at the state level (the rules vary by state).
- The earnings from a 529 account are not subject to federal tax, and the distributions are not taxed as long as they are used to pay for qualified educational expenses for the student named as the beneficiary of the plan.
- Another option under the 529 program is use a pre-paid college tuition plan for a qualified in-state public institution. This allows you to lock in current tuition rates no matter how old your child is.
5. Make charitable contributions
Making charitable contributions is another great way to reduce your tax bill. Donating cash, toys, household items, appreciated stocks and your volunteer efforts to qualifying charitable organizations can provide big tax savings.
- Time spent volunteering isn't tax deductible, but expenses incurred while doing volunteer work may be deductible, such as the cost of ingredients for a donated dish and certain travel expenses when attending a charitable event (14 cents per mile in 2020.)
- Your donations are only tax deductible if the organization you’re donating to is a qualified nonprofit organization.
- You must itemize your tax deductions in order for charitable contributions to lower your tax bill.
Except that for 2020 you can deduct up to $300 per tax return of qualified cash contributions if you take the standard deduction. For 2021, this amount is up to $600 per tax return for those filing married filing jointly and $300 for other filing statuses.
6. Harvest investment losses
Reporting losses on capital investments can also reduce your tax bill. “Loss harvesting” is considered to be a key year-end strategy. This is when you sell your investments to “realize” a loss(the act of selling at a loss). These losses can be used to offset capital gains taxes, dollar for dollar, reducing your overall tax liability.
- When you have more losses than gains, you can use up to $3,000 of excess losses to offset ordinary income.
- The remainder of the losses (in excess of the $3,000 allowed each year) can be carried forward year after year.
- Keep in mind that the IRS doesn't allow use of losses from a “wash sale"; when you purchase the same or “substantially similar” investment within 30 days before or after the loss.
7. Maximize your business expenses
Usually, business owners and self-employed taxpayers are able to use a much wider range of tax reduction strategies than individual taxpayers because of tax deductible business expenses. Some common business tax deductions include,
- office rent,
- home office expenses,
- the cost of acquiring and maintaining a vehicle for the business, and
The lower your net profit, the lower your self-employment tax will be, so writing off as many expenses as possible can help reduce your tax bill. Claiming business tax deductions can also lower both your income taxes and self-employment taxes, and you can deduct a portion of your self-employment tax payments on your personal tax return.
Bonus Tip: Deduct your self-employed health insurance
If you’re self-employed, you can usually claim a tax deduction for the health insurance paid for yourself, your spouse, and your dependents. This means that the premium paid for medical, dental, or long-term care insurance can reduce your taxable income, dollar for dollar. If you are a partner or a 2% S Corporation shareholder, you can benefit from this deduction as well, although special rules apply.
With TurboTax, we’ll help you determine what’s deductible and help guarantee you get all the credits and deductions you deserve.
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