How to Save Money on Taxes: IRS Approved
No one likes paying taxes and a large tax bill can ruin your day. In order to avoid this surprise, there are moves you can make to save money on taxes.
In many cases, if you want to learn how to save money on taxes then you will need to itemize instead of just taking the standard deduction, but the extra time it takes to do this can be well worth it. There are plenty of tax saving tips if you know what to look for.
How to Save Money on Taxes by Preparing
If you want to save money on taxes then it’s best to do some preparation in order to make sure you are taking advantage of everything.
Have Your Documents Ready
Before you sit down to do your taxes, gather your important documents. You want to make sure you don’t forget anything. It’s not hard to remember the obvious things, such as W-2s and 1099s, but you also want to make sure you gather valuable deductions.
Have Last Year’s Tax Return Available
This is a good idea, because this is a good reference point to see deductions you claimed in the past so you can maximize tax savings and not forget anything when filing this year. You may also need to include your previous year’s income when you file as an extra layer of security so having this information is going to be very helpful.
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How to Save Money on Taxes during Filing
Once you have prepared, there are ways to learn how to save money on taxes while filing. Be sure you are taking all the deductions you are eligible for. Many taxpayers are taking the standard deduction instead of itemizing but you should do what is best for you to get the most money. There are also a few credits that taxpayers usually miss every year that can allow you to save a lot of money.
Don’t forget about tax benefits for your dependents. Children aren’t the only type of dependents that can help you with tax benefits. If you are financially supporting a relative, you can claim the other dependent credit for non-child dependents. You do need to make sure you have the right Social Security Number details to do this.
How to Save Money on Taxes by Changing Your W-4
Your W-4 is a form you give your employer and it instructs how much tax you want to withhold from each of your paychecks. If you have had a big tax bill in the past and don’t want another surprise then raise your withholding so you can owe less when it comes to time to file your tax return. However, if you got a big refund, you can do the opposite, and this way you aren’t needlessly living on less of your paycheck throughout the year. While everyone loves getting a refund when you do get a refund that means you are just giving the government interest-free money throughout the year.
You can change this at any time. The 2020 version of the form is slightly different but does come with worksheets to help you figure out your withholdings. This new version doesn’t have the option to choose a number of allowances and instead, you provide dollar estimates for the payroll system to use. You can also select the head of household filing status but if you do select this, you want to have the amount of taxes that are going to be withheld from your pay to make sure it’s accurately aligning with your tax liability.
If you don’t want to reveal that you have a second job or get money from other job sources, there are some options for filling out your W-4. You can send estimated quarterly tax payments to the IRS yourself, instead of factoring that income into your W-4, or you can instruct the employer to just withhold an extra amount from your paycheck.
Put Money in Your 401K
When you have less taxable income, this means less tax. A 401k is a popular way to reduce your tax bill. The IRS won’t tax what you divert directly into your paycheck. Employers usually sponsor these types of retirement accounts but self-employed people are allowed to open their own. If your employer matches some of your contributions then you will even get some more free money to aid you in retirement.
Contribute to an IRA
If you aren’t able to contribute to a 401k, you can still reduce your tax bill by contributing to an IRA. There are two different types of IRA accounts. You will find traditional IRAs and Roth IRAs. You can deduct contributions to a traditional IRA but how much you are able to deduct will depend on how much you make and whether either you or your spouse is covered by a retirement plan at work. There are also limits on how much you can put into an IRA each year.
With both types of IRA accounts, a traditional IRA and a 401k, you not only lower your taxable income but you also won’t have to pay income taxes on the returns until you withdraw the money in your retirement. This means your money can grow tax-free until you need it for retirement.
Use College Savings to Your Advantage
Setting aside some money for your children’s education is not only beneficial for them but it can also help reduce some of your tax bill. One popular option is to make contributions to a 529 plan. This is a savings account operated by an educational institution or a state. You aren’t able to deduct your contributions from your federal income taxes but you may be able to on your state taxes if you are putting money into their specific plan.
There could be gift tax consequences if there are contributions that exceed a certain amount. There are different expenses that qualify under a 529 plan. College fees, tuition, books, and computers often count. You are also allowed to take out some money to pay for religious and private K-12 schools.
Use a Flexible Spending Account
The IRS will let you funnel some tax-free dollars that come directly from your paycheck into your account each year. If your employer offers flexible spending accounts then taking advantage of this can lower your tax bill. Keep in mind that there are limits. You do have to use this money during the calendar year for dental and medical expenses. However, there are some everyday items, such as bandages and acupuncture, that also qualify for you to spend this money on. There are some employers that allow you to carry money over to the next year.
Use a Dependent Care FSA
This type of FSA comes with a twist but is also another way to manage your tax bill if you have an employer that offers it. With this, the IRS excludes up to $5,000 of your pay to divert to a Dependent Care FSA account. This means that you are not paying taxes on that money and it’s a big bonus for those with kids under 13 that can use that money for daycare, preschool, and after-school care. Eldercare may also be included.
Take Advantage of Your Health Savings Account
If you have a health plan with a high deductible then you can lighten some of the tax load and use a health savings account. This is a tax-exempt account that you can use to pay medical expenses. Contributions to this account are tax-deductible and withdrawals are also tax-free, as long as the money is used for qualified medical expenses.
Your health coverage will determine how much you can add to your account. Your employer may offer a health savings account but you are also able to start your own at a financial institution.
Find Out if You Are Eligible for an Earned Income Tax Credit
Rules for the EITC can be complex. However, if you have earned less than $57,000 then it may be something you want to look into. The amount of tax credit you qualify for depends on your marital status, how many children you have, and your income.
What Is Tax Credit?
A tax credit is a reduction in your actual tax bill. A deduction just reduces how much of your income you are taxed on. A credit can reduce your tax bill to zero and depending on the credit, you may get money back from the IRS so it’s always worth investigating credits.
How to Save Money on Taxes by Donating Money
Charitable contributions are deductible and you don’t have to make these contributions in cash. For example, if you have donated old sporting gear, household items, food, or clothes, these items can also lower your tax bill if you have donated to an actual charity and you got a receipt.
If you are using a tax software program or other tax tools, many include a module that will estimate the value of the item you donate. Keep a list of any times you are donating since it could add up to a big deduction depending on the value of the items.
Keep a Record of Medical Expenses
If you have had costly dental care, medical expenses, or been in the hospital then keep these receipts. Generally, you can deduct qualified medical expenses that are more than 7.5% of your adjusted gross income for that specific tax year. For example, if you have an adjusted gross income of $40,000 then expenses beyond that first $3,000 could be deductible. If you had $10,000 in medical bills during this time then that means $7,000 could be deducted.
Sell Certain Stocks Weighing Down Your Portfolio
Getting a tax deduction can make it easier to unload some bad stock picks that now are weighing down your portfolio. You are able to deduct losses on stock sales, which can counteract any capital that is taxable you may have gained. There are certain limits depending on your filing status.
Smart Investing
It’s important to note that you shouldn’t let tax avoidance become a substitute for any wise investing. You should be selling a stock that doesn’t truly work in your portfolio and not doing it just to get a tax break. If you do decide to buy back the stock within 30 days then the IRS can actually take back the deduction.
Get the Timing Right on Certain Things
When it comes to a tax perspective, there is a big difference between doing something on the last day of the year, December 31st, and doing it on January 1st. If you are aware there is going to be an upcoming expense that is going to be deductible, think about whether or not you can pay for it in the current year instead of waiting for the next year.
For example, if you make the January mortgage payment in December then you can deduct more mortgage interest. If you know that you could be near the threshold for medical expenses then moving up that procedure can allow you to deduct the cost.
Pay off Non-Qualifying Home Loans
This may not save you a lot of money on your taxes but non-qualifying home loans don’t do anything to help you with taxes so it’s best to pay them off. Taxpayers that have an outstanding home equity loan should think about paying it off since interest payments can be costly, especially if there are no longer any tax benefits to offset it. Evaluate the interest rate you are paying on the home equity loan versus what you may have earned if you invested.
How to Save Money on Taxes by Paying Attention to Your Filing Status
Not many people give a second thought to tax filing status but it can have an impact on the taxes you pay. What filing status you choose will determine the tax bracket you fall into. Your filing status is also important for calculating your standard deduction.
These are the filing statuses you can pick from:
- 1. Single is the status you would choose if you aren’t currently married. It also applies if you are legally separated or divorced under state law.
- 2. You can choose married filing jointly or married filing separately. You may want to choose married filing separately if it results in less money owed than if you are filing a joint return. You may want to do taxes with both statuses so you can see how the status affects what you owe. You can also use married filing separately if you want to be responsible for only your tax burden.
- 3. The head of the household status will usually only apply if you are not married, but there some instances where there are special rules. In order to apply for this status, you must have paid more than half the cost of keeping up for the home for both yourself and the qualifying person. You don’t want to choose this status by accident and make sure that all the rules apply before choosing it.
- 4. The qualifying widow(er) with dependent child status is also offered to those whose spouse died during the tax year or the two preceding years and who have a dependent child.
How to Save Money on Taxes with Deductions
There have already been some deductions discussed but it’s important you are aware of all the deductions you can take in order to make sure that you are taking full advantage and saving the most money:
If you have student loans, you are able to deduct some of the interest you are paying on the loans each month.
You may even be able to take this deduction if you opt for the standard deduction.
Local property taxes and mortgage interest can also be eligible for partial deductions.
If you work from home or are a freelancer then you may be able to deduct business-related expenses, such as the cost of your home office. You may also be able to deduct certain supplies.
How to Save Money on Taxes with Credits
Credits are another great way to save money on taxes. Learning how to save money on taxes with credits can be even more beneficial than deductions since they offer more advantages. The Earned Income Tax Credit can be one of the main ones but there are also there ones available, such as the American Opportunity or Lifetime Learning Credits.
To Sum Up,
When learning how to save money on taxes, there are a lot of things to keep in mind. Be sure that you prepared to file your taxes with all the important documentation. There are a lot of different things you can do to save money on taxes. Pay attention to different deductions and credits that you may be eligible for and consult with a tax professional about your filing status.