Your income is taxed at the local, state and federal levels. On top of that, earned income is subject to more levies to fund Medicare and Social Security, to name a few. Although paying taxes is a civic duty, some strategies may still allow you to reduce the amount and protect your income.
Consulting with aprovider of tax relief services is a good first step. They will most likely recommend a strategy to help minimize tax returns. Some strategies might include the following steps.
Aim for Long-Term Capital Gains
In growing wealth, investing is an important tool. One of the biggest benefits of investing in bonds, mutual funds, real estate and stocks is the favorable tax treatment for long-term capital gains.
For instance, an investor with a capital asset for more than a year benefits from a preferential tax rate of 20%, 15% or 0% on their capital gain. The rate depends on their current income level. If they hold their asset for less than a year before they sell, the state taxes capital gains at ordinary income rates. If you want to grow your money, take the time to understand short-term versus long-term capital gains.
Another way to offset capital gains tax liability is tax-loss harvesting. This involves selling securities at a loss. If your capital losses exceed capital gains, the net capital loss or the lesser of $3,000 of the excess losses can be deducted from other income.
Invest in Municipal Bonds
Buying a bond means lending funds to a local or state government-owned entity with a set number of interest payments over a set period. Once the bond matures, the entity pays the full amount of the original payment to the buyer.
Interest on these bonds is exempt from federal taxes. It can also be exempted from taxes at local and state levels, depending on your location. Investors are interested in municipal bonds because they are simply tax-free interest payments.
Open A Business
Apart from creating more income, opening a business offers numerous tax advantages.
By following the guidelines of the Internal Revenue Service (IRS), a business owner can deduct a part of their home expenses via the home office deduction. You can also deduct a portion of the internet and utilities used in your operations from your income. To claim these deductions, you must start a business and make a profit.
When used during your business, you can deduct expenses from your income to reduce your tax obligation amount. For self-employed individuals, the most important tax deductions are health insurance premiums.
Claim Tax Credits
The IRS has many tax credits that reduce taxes (e.g. Earned Income Tax Credit). In 2021, a low-income taxpayer could claim the following credit amount (based on the number of kids that they have):
- $543 if you have no children
- $3,618 if you have one child
- $5,980 if you have two kids
- $6,728 if you have three or more qualifying children
For 2022, the IRS raised the amount. The changes are:
- $560 if you have no children
- $3,733 if you have one child
- $6,164 if you have two kids
- $6,935 if you have three or more qualifying children
Another option is Saver’s Credit for lower- and moderate-income generating individuals who want to save funds for their retirement. They can receive up to half of their contributions to an IRA or ABLE account.
The American Opportunity Tax Credit offers $2,500 annually for eligible students for the first four years of their schooling. On the other hand, the Child and Dependent Care Credit can offset qualified expenses for the care of dependents who are either children or people with disabilities.
Consider a Health Savings Account (HSA)
If you have a high-deductible health insurance plan, reduce your taxes by using a health savings account (HAS). Similar to a 401(k), contributions to HAS (which your employer can match for you) via payroll deductions are excluded from your employer’s taxable income. Direct contributions to the HAS are even tax-deductible from your income.
For 2021, the maximum deductible level is $7,200 for a family and $3,600 for an individual. The amount rose for 2022. The maximum for families now stands at $7,300 while individuals have $3650. These funds can grow without paying taxes on your earnings. Another benefit of the HSA is that when you pay for medical expenses, your withdrawals are not taxed.
Although paying taxes is a legal responsibility, you can reduce the amount you have to pay. Fortunately, you don’t need a high school degree to know about your tax rights. Educate and empower yourself by spending a few hours on the IRS website. Learning more may save you thousands of dollars in tax savings.