Description: There are ways to decrease your tax liability legally and ethically. With an understanding of tax laws, you can keep your money and make it work for you.

You’ve earned your money, so of course you want to figure out how to keep as much of it as possible. We know taxes are inevitable, but that doesn’t mean we have to watch all of our hard earned money be siphoned. Instead, what if it were put to good use and helped decrease our tax liability in the process? In fact, under the right circumstances, the government even offers programs that also achieve this same goal. You just have to know what to look for.

Contribute to a Retirement Account

The best way to decrease your tax liability is to contribute to a retirement account. It’s the easiest way to get started. The most common accounts are an IRA or employee sponsored 401(k). Contributions to these accounts are made from your taxable income, so when your tax liability is calculated, your overall amount is decreased. As an added bonus, you will set yourself up for a comfortable retirement in the process. 

If you are self employed, there are retirement plans specifically set up for you, as well. They have a slightly different classification, but still serve the same purpose: contributions from taxable income toward your future retirement. Partner with a financial advisor to discuss the best option for you.

Take Advantage of Employer Benefits

If your employer offers benefits such as medical, dental, and vision insurance these paycheck deductions are taken from your taxable income. Just as your 401(k) deductions lower your taxable income, so do these employer benefits. Some employers offer Flexible Spending Accounts and Health Savings Accounts to allow you to set money aside for medical expenses. Taking advantage of these programs all help to lower your taxable income.

For the self-employed, a tax advisor can help you determine whether or not any medical plans you purchase on your own are tax deductible. By deducting these expenses, you will lower your overall tax liability, as well.

Claim Business Deductions on a Side Hustle

The side hustle has become a popular way for people to make extra cash on their own terms. Many side hustles, however, leave the burden of reporting taxable income to the IRS on the person earning the money. In order to avoid being at the center of an IRS investigation, it’s important that you report any income not reported by an employer. But did you know you can deduct expenses directly related to your side hustle? For example, if you are a driver, you can calculate mileage reimbursement. There is the possibility for a qualifying home office expense. This is another area where a relationship with a qualified tax advisor will prove useful in maximizing your deductions to reduce your liability.

Deduct Self Employment Tax

As an employee, your employer pays half of the Social Security and Medicare costs deducted from your paycheck. When someone is self employed, they don’t have that luxury. In fact, they are imposed with a 15.3% Federal Insurance Contributions Act(FICA) tax. They are taxed on all earnings to cover Social Security and Medicare programs. Instead of wondering why self employment is worth it, know not all hope is lost. The government allows you to deduct 50% of the  FICA tax. This eases the tax burden so you can continue doing what you love. 

Business Travel Expense

Any travel expenses related to business can be deducted from your taxes. This includes airfare, hotel accommodations, meals, etc. However, the IRS takes business travel claims very seriously. If you cannot prove the legitimacy of every itemized expense, it will get rejected. For example, family vacations cannot be claimed as business travel, unless you can prove there was a reason for the claim. Even then, it is not likely that the entire trip will be accepted as an expense–only the portion legitimately used for business.

Find out if You are Eligible for the Earned Income Tax Credit

The Earned Income Tax Credit (EITC) is designed to help low to middle-income families receive a tax break. The qualification standards can get a little tricky, but if you think you fit into those categories it is worth looking into. The IRS considers income, marital status, and number of children when qualifying people for the EITC. If approved, you will receive a dollar-for-dollar decrease on your overall tax bill in whatever amount you qualified for.

Open a 529 Plan

Do you have kids? Starting a 529 college plan will not only decrease your tax liability, but it will boost their college savings as it grows interest over time. It’s no secret that a college education only keeps getting more expensive every year. Contributions to a 529 may be tax deductible at the state level. With rising costs of tuition and fees, preparing early will not only give you the peace of mind you need, but save money on taxes. 

Take Advantage of Higher Education Credits

The government has tax credits that offer valuable savings for students pursuing higher education. The American Opportunity tax credit is available for the first four years of your college education. This credit offers up to $2,500 per student each year it is claimed. However, since it is a credit, the amount is deducted from any tax you may owe the government. If the $2,500 is greater than what you owe, you could receive a maximum of $1,000 refunded to you. 

The Lifetime Learning Credit is also a great option for adults trying to further their education and training. This credit of up to $2,000 per year goes toward paying for college and furthering your career. 

Deduct Private Mortgage Payments

Private Mortgage Insurance (PMI) is required by lenders when a home has less than 20% equity. This protects the lender in the event a borrower stops making payments. The amount you pay in premiums is currently tax deductible. In 2017, the Tax Cuts and Job Eliminations Act ended PMI deductions. But they were reinstated in 2019 and are available to this day. The IRS has allowed for retroactive PMI deductions for 2018, but you should talk to a tax advisor. Decide if the amount you paid in PMI premiums is worth opening up a previous tax return. Anytime you make changes to an old return, you run the risk of an audit.

Tax-Loss Harvesting

Have you made an investment only to experience buyer’s remorse? The good news is, you don’t have to consider all as a loss. In fact, you can profit from the loss, in a manner of speaking. For investments that have lost value, and you don’t expect them to recover, you have the option of selling them off to reduce your current year tax liability. You can write off the amount of the loss from your original purchase amount (up to $3,000) against your income. The reverse logic also holds true. If you have seen substantial growth in an investment, you may choose to wait to sell if the taxation rates are high.

Max Out Retirement Savings

As of the 2020 tax year, most people can contribute up to $19,500 to their 401(k). For people age 50 and over, they can add an additional $6,500 to this retirement account. Not only can maxing out your contributions significantly decrease your overall liability, but it has the potential to have an impact on which tax bracket you belong to. If your overall tax bracket decreases, so does the tax percentage applied to your income.

Give Generously

One of the easiest ways to lower your taxable income is to find charitable organizations to donate to. What is considered a donation? The good news is, a donation doesn’t have to be monetary. Donating household goods, clothing, cars, and electronics are all tax deductible. In order for your donation to be considered tax deductible, any donation of money or goods must be made to a non-profit organization, and they must provide you a receipt of the transaction. A receipt of donated goods should include an approximation of the value of the goods donated.

It’s all About Timing

The tax year runs on the calendar year. So, your tax liability is based on all of your financial activity between January 1st and December 31 of the current year. If December comes and you discover there are actions you have been putting off, don’t wait any longer. On New Year’s Day the clock resets. If you can pay off tax deductible medical bills, do it now. Contribute extra money to your retirement accounts and max out contributions if possible. Add extra money to your kids’ 529 accounts. Future you will thank me.

Final Thoughts

With a little planning, you can decrease your annual tax liability and make your hard earned money work for you. Whether you are setting yourself up for the future, helping those in need, or preparing for medical expenses, your financial status will remain stable and secure. 

 

Lyle David Solomon Bio

Lyle Solomon has considerable litigation experience as well as substantial hands-on knowledge and expertise in legal analysis and writing. Since 2003, he has been a member of the State Bar of California. In 1998, he graduated from the University of the Pacific’s McGeorge School of Law in Sacramento, California, and now serves as a principal attorney for the Oak View Law Group in Los Altos, California.