If you want to avoid falling behind on your taxes, you first have to learn how to reduce tax liabilities. Despite the IRS imposing jail time and stiff penalties, it’s shocking how many Americans fail to pay taxes on time. A recent study shows that Americans owe the government more than $144 billion in back taxes, interest, and penalties in 2021.
You can reduce tax liabilities by understanding the tax deductions and credits you’re eligible for. It’s also important to calculate the total tax debts owed by taxing authorities. Your tax liabilities may include income taxes, capital gains tax, and sales tax.
Reducing tax liabilities is a form of tax avoidance. Unlike tax evasion (which is illegal), tax avoidance can help structure your transactions to lower the tax bill.
If you’d like to cut costs on taxes this year, you’ve come to the right place. Use any of these tax-saving techniques to reduce your tax bill and lower your tax bracket:
Check Your Eligibility for EITC (Earned Income Tax Credit)
You may qualify for an EITC of up to $7,000. However, it will depend on your current income and marital status. Your eligibility for the EITC may also depend on the number of kids you have.
An EITC is a refundable tax credit awarded to low and moderate-income working people with kids. You should have an investment income below $3,650 and a Social Security number to qualify for this credit. The IRS also requires you to claim a filing status and be a U.S citizen.
A tax credit reduces your existing tax bill to relieve you when filing taxes. Unlike a tax deduction, it doesn’t reduce the amount of income taxed by the IRS.
You can even get a refund when the IRS doesn’t require you to pay federal income tax. The IRS will consider your family size and income when calculating your EITC. Married couples must have an income limit of $55,844 while single taxpayers $15,820 to qualify.
Change Your W-4
When employed, you’re required to give a W-4 form to your employer. This form will instruct them on the amount of tax they should withhold from your paychecks.
If you have a huge tax bill, raise the withholding amount to reduce your tax liabilities. If you have a tax refund, reduce the withholding amount to save money off your paycheck.
Always use correct tax-filing information when tweaking your W-4 form. You should also update your current family status on the form as your tax situation changes.
The IRS will require you to give accurate estimates of your income sources. They will also require you to estimate your deductions when filing an income tax return.
Claim Business Deductions With Your Side Hustles
As a self-employed individual, you can be eligible for business deductions. Your self-employment status may apply to side hustles or freelance projects.
Taxing authorities may give you business deductions on business-related shipping, mileage, and advertising. The deductions may also apply to your business memberships, website fees, and office supplies, among other operational expenses. Premiums on your long-term, dental, and health insurance may also be deductible.
Maintain proper records in your side hustles to get consistent deductions. Keep records that tax authorities can use to audit your business.
Contribute to a Health Savings Account
Opening a health savings account will help lower your tax liabilities if you have an eligible health care plan. You may get an HSA when employed or open one at a relevant financial institution. The tax authorities will offer you deductions when you withdraw money from the account to pay for various medical expenses.
You can deduct your HSA deposits from the income used to pay federal income taxes. The IRS also allows you to spend money on your HSA on anything you want after turning 65. Check out https://www.taxfyle.com/freelance-cpa-jobs if you’re looking for or want to work as a tax expert.
Make Use of Retirement Accounts
You qualify for deductions every time you deposit money in your IRA and 401(K) accounts. Retirement saving is part of the tax liability reduction strategies you should use. Your retirement savings will also grow tax-free until the day you retire.
You can only contribute to your 401(K) account by the end of the calendar year for the deposits to be tax-free. Your contributions to an IRA account should be made by April 15 for them to qualify for the deductions. You can also open these retirement accounts if you are self-employed to enjoy the tax benefits.
Aim for Long-Term Capital Gains
Invest in real estate, mutual funds, and stocks for long-term capital gains to reduce your tax liabilities. You get to enjoy tax rates of 0 percent, 15 percent, or 20 percent on the capital gains when you hold a capital asset for more than one year. The tax rates will depend on your income level and period of withholding.
The tax authorities will tax your capital gains at normal income rates if you hold them for less than a year before you dispose of them. You can also reduce your tax liability through tax-loss harvesting if you sell securities at a loss. Consult with an investment advisor and tax planner for help to reduce losses and increase gains on your investments.
Give Your Money Away to Charity
You get to enjoy tax deductions when you contribute to charity through cash or any form of payment. Donating items like clothes, old sporting gear, and food will also help lower your tax bill. The tax authorities will require you to give a receipt of the donation for you to qualify.
Before donating anything, estimate their value and list them down. You can use a charitable giving tax savings calculator online to estimate the deductions.
Now You Know How to Reduce Tax Liabilities
Finding ways on how to reduce tax liabilities can save you a lot of money. All the methods discussed in this guide are legal and practical. They’ll help you stay tax compliant and gain deep insights into your financial future.
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