Your Guide to Lowering Your Personal Taxes
Planning your taxes before they are due in April can help you with lowering your personal taxes, as well as tax management.
There are many tax tools to use but you need to have some basic understanding of how taxes work and what you can actually deduct.
What Taxes Do You Pay?
Yes, you are paying taxes come April 15th, but there are also income taxes you pay throughout the year. It can be easy to feel overwhelmed with how often you are paying taxes, whether it’s indirectly or directly. In order to know more about lowering your personal taxes, you need to know what taxes you are paying.
You pay a variety of different taxes that are taken out by your employer before you even see your paycheck. Depending on where you live and when you spend part of your paycheck buying items, you then also pay sales tax on every dollar. If you instead put your paycheck into savings and then earn some interest, you pay taxes on that interest. If you own property or a home, you will be paying property taxes. This can be a part of your monthly payment and paid out of your escrow account when taxes are due each year but some people choose to pay them out of pocket yearly. If you own a car, you either paid taxes upfront or had the taxes built into your car payment.
Taxes on your paycheck
If you take a look at a recent pay stub, there will be different lines and abbreviations. Your gross pay is indicated near the top. Then you will see itemizations for what is taken out. Sometimes there will be two columns on your pay stub, one for what was taking out for this specific check and your year-to-date totals.
One of the larger numbers will be for Social Security. It can also be called OASDI. Sometimes it is paid with Medicare and labeled FICA. Another subtraction you will get is the federal income tax. This is a tax on your income at the federal level. Keep in mind that you technically should be paying taxes on all your income and not just what you get from working your job.
If you sell something on eBay, that’s considered income. If you work for a family member and get paid on the side as cash, that is also income. Technically, you are supposed to claim all your income. Most people will also see state income taxes withheld on their pay stub. It will depend where you work and live. Other deductions can be for health insurance, voluntary contributions, or retirement plans.
Federal Taxes You Pay
April 15th is the deadline for filing your federal taxes. It’s likely you will have done this before the deadline. Doing your taxes can seem like a lot but it will be about two things. These items are figuring out how much you owe in a year and figuring out how much you have already paid. If you paid more than you owe with deductions from your paycheck then you get a refund. If you have paid less then you owe money.
Many people think that big refunds are a good thing. If you get a big refund, it means you have loaned the federal government your money for free throughout the last year. Yes, it is nice to get a big chunk that you could spend but this could have meant more money in your pocket throughout the year. If you do have a big refund, you can fix it for the next year.
What Is Your AGI?
Your AGI is your adjusted gross income and understanding this number helps with lowering your personal taxes. This is your income from all sources but minus any adjustments to income you qualify for during the year. Adjustments are deductions but you don’t need to itemize in order to claim them. Your AGI goes up if you have additional income and don’t qualify for any adjustments.
Your AGI shrinks if you have adjustments and no additional sources of income. Additional sources of income can be taxable state tax refunds, alimony, income through self-employment, unemployment compensation, and capital gains. Adjustments can include moving expenses for members of the armed forces, student loan interest paid, alimony paid, classroom-related expenses paid by educators, and contributions to health savings accounts.
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Changing Your W-4
Ideally, when you file your federal taxes you want a small refund or to owe very little and this comes down to getting your W-4 correct. This is part of tax management and lowering your personal taxes. You may have filled one of these out when you were first hired at your job. You can also ask your employer for another one or download it from the IRS website and change your withholding any time.
Federal law dictates Medicare and Social Security and those percentages are fixed. The federal income tax dollars that are being withheld can be changed on your W-4. You can decide on the amount that comes out via withholding. The form tells the employer how much to take out of your check for federal taxes. The bigger number you claim on your W-4, the less your employer takes out each paycheck.
It can be hard to figure out how to determine the number of allowances to claim. If you aren’t sure how to fill out the form, there is an allowance worksheet that helps you figure out how much to claim. If you got a huge tax bill when you filed your taxes then increase your withholding. If you got a big tax return last year then reduce your withholding.
See if you are exempt from withholding. Being except means that our employer won’t withhold federal tax income from your pay but Medicare and Social Security still come out. You can be exempt if you got a refund from all your federal income tax withheld because you have no tax liability. It helps to be strategic about your personal allowances.
Some examples of things that will allow you to claim an allowance are having a spouse, having kids, or filing as head of household on your tax return. It can be tempting to want to claim a lot of allowances so you get to keep more of your pay but this can generally be a bad idea. This will leave you with a bad surprise come tax time. Don’t forget to file a new W-4 when your life changes. If you get divorced or married, have a kid, buy a house, get a raise or pay cut, or only work part of the year, you may want to make some adjustments.
Additional Income on Your Taxes
If you have income from sources other than your full-time job and these sources don’t withhold federal income taxes then you have different options.
You can pay your estimated taxes throughout the year. The most common way to do this is quarterly. If you make enough non-traditional income, this could be required. You can also set up a separate fund account for taxes. Each time you make a big sale or get paid for freelance or contract work, set aside a percentage to pay specifically for taxes. Many people will recommend a quarter of the income so you don’t get stuck with not having enough to pay. If you are also working with a traditional employer, you can have them withhold more taxes each paycheck.
Ways to Work on Lowering Your Personal Taxes
You may not be able to take all the steps to lowering your personal taxes but each step you are able to make means that you can spend less in taxes.
Contribute the Most to Your Retirement Accounts
This will help set you up for the future while lowering you personal taxes. Unless you have a Roth IRA, you can take deductions for the contributions in the year you make. This will allow you to deduct a lot of money if you are contributing as much as you can. If you are able to max out both an IRA or 401k then you are able to reduce your taxable income by a lot.
Keep or Get Health Insurance
While at the federal level the tax penalty may have been repealed if you are going without health insurance, this doesn’t mean you may be off the hook. States have also imposed the penalty if you don’t have qualifying health insurance. When lowering your personal taxes, the last thing you want to do is owe a higher state tax bill since you don’t have insurance to protect your family. Check your state’s rules and see if there is a penalty or just be sure to have coverage since coverage can really help protect you from a finance disaster if you get hurt or sick.
Invest in a HSA if You Are Eligible
If you have a health plan with a high deductible then a health savings account can be helpful. When you put money into the account, you are investing the funds with pre-tax dollars. If you max out your contributions, you can reduce your taxable income by a good amount depending on your current deductible. You take out the money tax free to cover your healthcare costs. If you don’t use the funds for healthcare, you may also have the option to withdraw the money after age 65.
Keep Track of Medical Cost
If you have substantial medical expenses, you may be able to take deductions for funds you spent. In 2019, you were allowed to deduct an unreimbursed allowable medical expense if they exceeded 10% of your income. Keeping your bills allows you to see if this deduction makes sense for you come tax time.
Save for College for Your Kids
If you have a kid then you want to save for college in a 529. Contributions to a 529 are not tax deductible on a federal level but the funds do grow tax free. Depending on where you live, you could be able to deduct the contributions from state taxes. Reducing your state tax bill is a good way to work on lowering your personal taxes with the changes that went into effect in 2019.
Use Flexible Spending Plans
If you have an employer that offers a flexible spending account (FSA), you should take advantage. You are able to make contributions to a FSA with pre-tax funds to pay for qualifying out-of-pocket medical expenses. You do have to know the rules for these contributions. If you don’t spend the contributions, you lose them. If you know you have out-of-pocket medical costs frequently, putting money into an FSA can reduce taxable income and make these expenses cost less.
Bundle Deductible Expenses
There are lots of tax deductions that are available to you if you itemize. However, unless your itemized deductions exceed a certain amount, this practice won’t make sense. You can preserve the itemized deductions by bundling them.
Contribute to Charity
Charitable contributions are tax deductible so, if you are going to itemize, consider making generous contributions. You do need to make sure you are able to document the contributions you make and don't inflate the value of items you are donating.
Move to a Lower Tax State
This can be a dramatic move but one to work on lowering your personal taxes. There are some states where you could live where you don’t have to pay any taxes on your income, while others do have a huge tax burden. If you have flexibility in where you work or you are retired, a state where you pay less on your income could help keep more of your money in your pocket.
Purchase a Home
Buying a home can be a big decision but it can help reduce your tax bill. You can deduct mortgage interest and property taxes up to the cap limits. Interest on lines of credit or home equity loans can also be deductible if you use the funds to improve the home.
Make Energy Efficient Improvements to the Home
You can get a tax break if you make your home more energy efficient. Residential renewable energy tax credits can be available for installing solar power to the home or a solar powered water heater. You can also get tax credits for renewal energy fuel cells or wind turbines.
Have Children
While having children for tax purposes isn’t a good idea, there are tax benefits you get when you have a kid. These tax credits include the child tax credit. Having a kid could also make you eligible for an earned income tax deduction at a higher income if you are single. When you have a child, even if you give birth on the last day of the year, you are considered a parent all year long for tax purposes.
Deduct Business Expenses You Are Entitled To
If you are a business owner, you can still work on lowering your personal taxes. There are a lot of deductions available to business owners but many people don’t want to take advantage because they are afraid of being audited. If you are legitimately entitled to a deduction then don’t be afraid to claim it. Be sure that you know the IRS rules and make sure you are in compliance.
Consider Furthering Your Education
There is a lifetime earning credit you can claim if your income isn’t too high. The credit could be worth up to $2,000 and there isn’t a limit on the number of years you are able to claim it. The means if you take classes, even if you are not working toward a degree, you can reduce your tax bill and learn valuable skills to help with career opportunities.
Appeal Property Taxes
If you are looking at lowering your personal income taxes on the state and local level then you may want to appeal your property taxes. Many taxable properties in the United States have been over assessed. When you appeal property taxes, you are challenging the value of your home. The value of the home is used to determine how much you owe. If you can prove with a comparable sale or an appraisal that your home is actually appraised too high then you cut hundreds of thousands of dollars off this local tax bill. The process can be simple and involves paperwork and maybe attending a hearing.
Get Help from a Professional
Getting help from a tax professional can be the best way to work on lowering your personal taxes. Doing taxes can be complicated so chances are you can miss out on some deductions and credits you are entitled to if you are doing your own taxes. There are software programs available as tax tools that can help you catch the deductions and credits by asking questions about your life but there is no substitute for a real person helping you and getting tax tips.
What Are the Top Personal Tax Deductions?
If you are lowering your personal taxes, it helps to know the top personal tax deductions you should take advantage of.
Mortgage Interest
You can deduct mortgage interest but not the principal on a loan for your primary residence. For those homes that are purchased after December 15, 2017, you get to deduct the interest only up to $750,000.
State and Local Taxes
If you itemize then you can deduct local and state taxes. This includes property taxes and sales tax or state income, whichever is greater. In the past, there wasn’t a limit in this deduction but now there is.
Charitable Deductions
Your deduction for charitable contributions generally can't be more than 60% of your AGI, but in some cases 20%, 30%, or 50% limits may apply.
Medical Expenses
This also includes dental expenses that exceed a certain percentage of your income.
Student Loan Interest
You can deduct up to $2,500 in student loan interest payments. This is an above-the-line deduction that you can take without the need to itemize your personal deductions. This means that all taxpayers who qualify can take advantage of it.
Things You May Not Know You Can Deduct
When lowering your personal taxes, it helps to have an understanding of everything you are able to deduct, and this may include things you don’t know about.
Sales Tax
You may have the option of deducting sales tax off your federal income tax. If you live in a state that doesn’t have its own income tax then this can be a big saver. Even if you paid state taxes, the sales tax break can be a good deal for purchases such as a car or an engagement ring. The IRS will provide tables as a guide.
Tax Savings for Teachers
It’s rare to find a teacher who doesn’t use his or her own money to purchase items needed for the classroom. It allows for qualified educators to deduct up to $300 of out-of-pocket classroom expenses when they file their 2022 federal income tax return. You don’t have to itemize in order to take advantage of this.
Paying the Babysitter
No, you can’t deduct this expense every time you use a babysitter but you can if you pay for someone to watch your kids while you volunteer to work for no pay and for a recognized charity. It’s then okay to consider the cost of a babysitter also as a charitable contribution as long as you can document that you were volunteering at the time.
Self-Employed Social Security
The bad thing about being self-employed is that you have to pay 15.3% of your income for Medicare and Social Security taxes. This is the portion that is paid by both the employer and the employee. However, you do get to deduct 7.65% off your income taxes for the employer portion.
Can a Personal Loan Affect Your Tax Return?
Personal loans can be used for a number of different things, including to help pay down your debt. They are designed for general use and don’t have to be used for specific things. Although personal loans are added funds for you to spend, it’s usually not considered income. There will be some instances where a personal loan is considered income and, in these circumstances, a personal loan will affect tax returns.
When Is a Personal Loan Considered Income?
Since a personal loan has to be paid back it is generally not considered income. However, if a lender does forgive the loan it then becomes taxable income because you don’t have to pay it back. When the lender forgives a loan, it is then considered a cancellation of debt. If a lender only cancels part of the debt then only part of the loan is considered taxable. Most people aren’t lucky enough to have a personal loan forgiven so taking out a personal loan is not usually a huge issue when it comes to tax time.
While generally speaking canceled debt it is considered taxable income, there are some exceptions. If the loan is forgiven as a gift from a private lender then it’s not considered income. If the lender forgives a loan of $13,000 or less as a gift, it’s also protected. If a lender dies and then cancels your debt, it's not counted ether.
Your lender may send you a form called a 1099-C. This means you have to report the loan's principal and interest to the IRS as taxable income. If you use a personal loan for investments, qualified education expenses, or business expenses then the interest can be tax deductible.
Taking Out a Personal Loan to Pay for Taxes
If you file your taxes and owe money, you are supposed to pay that money by the deadline. If you don’t have the money, there are payment options with the IRS. However, these options can include interest and other penalties. Many people will consider taking out a personal loan to pay off the debt.
A personal loan can have advantages over other ways to pay off your tax debt. Personal loans can have a lower interest rate than credit cards. A personal loan will allow you to pay the IRS what you owe but you do want to make sure you aren’t paying more than what you are offered with the IRS payment plan.
When you make the decision to get a personal loan, you will need to know how to get one. You have the choice between banks and lenders. Banks can have lower interest rates but online lenders are more flexible when it comes to their terms and offering loans to those with bad credit.
Final Thoughts
There are a number of ways to work on lowering your personal taxes. It helps to understand the taxes you are paying, as well as your AGI and your W-4. There are a number of deductions you can take to help with lowering your personal taxes. With the tax changes in the recent years, you need to know if it makes sense to take the standard deduction or itemize your deductions. Working with a tax professional can be a great tool for tax management so that you can get the most out of your deductions and other decisions.