We understand that you hate shelling out a hefty amount to the taxman every year. However, just like a necessary evil, you must pay taxes, right? Amidst a year of inflation, recession, and high volatility in the stock market, you’d be strategizing your tax cut or finding ways to avoid taxes.
A calculated mix of investments, tax credits, and deductions can help you save millions! Well, this might give you the impression that tax saving is something illegal. We assure you that’s not the case.
Difference between tax avoidance and tax evasion
The US government has devised several strategies to help its citizens save taxes. You might already be familiar with some of the popular tax credits and deductions. Besides, we will recommend some investments in this article that should help you save tax.
Since most taxpayers are unaware of these legal tax-saving ways, they tend to miss them out. When you avoid paying taxes by adhering to the legalities, you simply save them!
Tax evasion is something different and a practice you shouldn’t probably indulge in. It involves deliberately concealing or misreporting your income to avoid taxes you should have legally paid. In other words, tax evasion means you simply refuse to pay taxes that the IRS deserves from you.
Here are some instances of tax evasion that you should refrain from indulging in.
- Hiding one or more of your income sources.
- Underreporting your income.
- Taking your taxable assets offshore.
- Using your business assets for personal purposes.
- Creating dummy corporations or shell companies.
- Claiming undue deductibles.
11 Tips to legally avoid taxes: Bank on your tax credits, deductions, and investments
Taxpayers often miss out on rightful deductions owing to a lack of information. Here are some legal ways you can deploy to save taxes.
1. Contribute the maximum to retirement accounts
2023 brings a positive development to taxpayers ready to increase their accumulations in retirement accounts. You can now contribute more to your individual retirement account as well as 401(k).
The authorities have increased the employee deferral limit from $20,500 to $22,500. Investors aged over 50 could deposit a maximum amount of $6,500 till last year. This amount has been increased to $7,500, enabling you to save even more taxes. These benefits are also applicable to most of the 457 plans, 403(b) plans, and Thrift Savings Plans.
Also, the authorities have boosted the contribution limits for IRAs. In 2023, taxpayers can save up to $6,500. Until last year, it was capped at $6,000.
2. Retirement accounts for freelancers
Being a freelancer or an independent professional, it pays to capitalize on your retirement investment opportunities to lower your tax burden. Here are two legal ways to underpay your taxes without bearing any consequences.
Individual Retirement Account (IRA): When freelancers contribute to a traditional IRA, they are exempted from the contributed money until they draw them during retirement. However, this withdrawal age is 72, leaving you plenty of time to consolidate your finances.
Roth IRA: If you contribute to a Roth IRA, you will be taxed on the amount you channel to this account now. However, when you retire, withdrawing the amount would be tax-free. For a Roth IRA account, the withdrawal age is 59.5.
Suppose you are in the 24% tax bracket. Contributing an annual amount of $9,000 to your IRA will legally save you income tax worth $2,160.
3. Take advantage of your HSA Account
Allocating funds for medical purposes under an HSA account can help you save tax.
Are you privileged for an HDHP (high deductible health plan) through your recruiter? This might allow you to access an HSA (Health Savings Account) so that you don’t pay medical expenses from your pockets.
Well, taxpayers need to contribute to this account through their pre-taxed income. This would eventually reduce their taxable income. The medical expenses that you qualify for wouldn’t invite any tax.
You can take tax advantage legally from your HSA Account in three ways:
- Pre-tax payroll HSA deductions
- No tax for medical expenses that you qualify for
- Tax-free growth
Before you start contributing to HSA to legally save taxes, consider these aspects:
- To qualify for an HSA, taxpayers need to enroll for an HDHP at the outset.
- HSAs come with some upper caps on contributions. For instance, freelancers in 2023 can contribute up to $3,850 to self-only HDHP coverages. Again, if you have family coverage, the limit is $7,750.
- While opening the HSA account, it’s imperative to choose a beneficiary.
4. Capitalize on your FSA (flexible spending account)
Don’t have access to your HSA account? Well, this shouldn’t dampen your spirit since you can still allocate funds tax-free for medical purposes. Some employers don’t offer HSA accounts. Instead, they provide flexible spending accounts (FSAs), which prove to be much more versatile. While HSAs allow taxpayers to put aside funds solely for medical purposes, you can allocate funds to your FSA for:
- Buying prescription medicines
- Managing medical expenses
However, if you don’t use the money by the year-end, the funds may be forfeited. So, open an FSA account only when you are sure of your fixed expenses.
Funding of your FSA takes place through your payroll deductions. Later, you can use the amount in different avenues, from purchasing over-the-counter medicines and dental treatments or even co-paying your insurance premiums.
Most companies offer flexible spending accounts for both dependent and healthcare. Like HSA, taxpayers should know the limits they can deposit. In 2023, the FSA upper limit has increased from $2,850 to $3,050.
5. Claim tax credits
While financial experts advise not to apply for tax credits that you aren’t eligible for, you might qualify for some of these. This ensures that you can reduce your tax liabilities and taxable income legally.
Let’s take a look at the tax credits you can be eligible for.
Earned Income Tax Credit
Being a low or moderate-income taxpayer, you may qualify for the Earned Income Tax Credit. The amount you can qualify for depends on the number of children.
- Taxpayers with no children can claim credits up to $600.
- Taxpayers having only one child can claim up to $3,995.
- If you have two kids, you can be eligible for a tax credit of $6,604.
- The maximum earned income tax credit is $7,430 if you have three children.
All these slabs were increased in 2023, compared to what eligible taxpayers used to receive in 2022.
American Opportunity Tax Credit
Under the provisions of this tax credit, eligible students can qualify for a credit of a maximum of $2,500 a year for the initial four years of their higher studies.
Also, don’t overlook the Lifetime Learning Credit. This privilege can help you qualify for 20% credit or $2,000 a year, considering the qualified expenses to be $10,000.
Taxpayers with low or moderate income may also qualify for the Saver’s Credit while securing funds for retirement. You might be eligible for a credit amounting to 50% of your contribution to an ABLE account, an IRA, or a plan.
Child and Dependent Care Credit
Based on your income, the Child and Dependent Care Credit can help you save taxes on expenses you make to take care of your children. Even if you have any disabled dependents, you would be eligible to claim the credits.
6. Make energy-efficient home improvements
Do you know that making energy-efficient improvements in your home can make you eligible for a tax credit?
The Inflation Reduction Act (2022) entitles US residents to get tax relief on the expenses they incur while improving the energy efficiency of their homes. However, it’s wise to know the exact upgrades that can qualify you for this tax credit. Also, keep the bills, invoices, and receipts of these appliances and their installation costs handy.
Adding insulation, heat pumps, or carrying out home energy audits can help you claim tax credits of up to $1,200 annually.
7. Take advantage of eligible deductions
Just like your tax credits, check the deductions you are eligible for. Before filing your tax returns, make sure to scrutinize all the points where you can save tax.
In 2023, the US government raised the standard deduction for single tax filers to $13,850. If you are jointly filing your income tax with your spouse, you can be eligible for a maximum deduction of $27,700.
Don’t overlook the interest you have been paying on your home mortgages. Reach out to a tax professional if you are in a dilemma about whether you should go for a standard deduction or itemize.
8. Contribute to 529 college savings
US citizens willing to legally curtail their taxes may consider contributing more to their 529 college savings. Initially, you could use this tax-advantaged savings plan to manage educational expenses at the post-secondary level. Later, the coverage was expanded to the K-12 level and apprenticeship programs as well.
Under 529 plans, taxpayers can choose between prepaid tuition plans and education savings plans.
Prepaid tuition plans: The account owner holding a prepaid tuition plan can continue to pay the existing tuition rates for attending designated universities or colleges in the future. This implies they can lock the rate at the lower end.
Education savings plans: These are tax-deferred plans for education. The positive aspect of these plans is that they grow without tax implications. For qualified educational expenses, you can withdraw them tax-free.
9. Claim business tax deductions for your side-hustles
It’s illegal to claim tax deductions for your hobbies. However, taxpayers can always claim deductions for side hustles that qualify as businesses.
Whether you write blogs as a freelancer or dedicate your leisure hours to a ride-sharing business, you can legally claim tax benefits.
To give you a concrete idea, here are some business deductions you can claim.
- Travel expenses related to business
- Vehicle mileage
- Website fees
- Advertising and shipping
- Internet bills for business
- Memberships and dues
- Professional publications
- Stationeries and office supplies
However, make sure not to over-exploit or take undue advantages by categorizing your personal expenses under business ones.
10. Let out your home for business meetings
If you are a homeowner, you can bank on the provisions of the Augusta rule to save taxes. The rule states that letting out a residential space for hosting business meetings for a period not exceeding 14 days doesn’t require you to inform the IRS about the income. However, there’s a catch in this clause: the primary owner’s home cannot be their business space. So, if you don’t inform the IRS about this income, you need not pay taxes!
This can be a legal way for business owners operating without a home office. If you are under this category, consider renting a room in your own residential premise to host a business meeting. Deduct this cost from your business taxes. This way, you need not claim the rental fees when you file your personal tax return.
However, don’t charge an exorbitant amount from your business in a bid to avoid taxes. Consider the local rental rates before you file your tax. Tax officials expect the rate to be in line with the ongoing market rates. Also, ensure proper documentation about the purpose, place, duration, and time of the meeting.
11. Donate stocks to avoid capital gains
How about making charitable gifts by donating stocks to avoid capital gains tax?
Financial experts advise donating an appreciated stock from your portfolio. This way, you need not pay capital gain taxes on the profits you make on the value appreciation of the stock. Besides, you would be contributing to a charitable cause, which would bring in further tax benefits.
Many taxpayers donate stocks or gift them to take advantage of this dual-benefit mechanism. Reach out to a charity and check whether or not they accept stocks or securities.
With these guidelines, you have probably unlocked new avenues to save tax! All these procedures are legal, and you needn’t worry about facing any consequences as long as you are transparent with your documentation.
Consider talking to a professional tax preparer or accountant to bank on all the legitimate ways to save tax. Also, choose the right tax filing status so that you remain eligible for the maximum number of deductions and credits.
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