Lowering Personal Taxes Legally
Tax burdens can become overwhelming for individual taxpayers. They may benefit from taking the time to step back and develop a strategy to minimize the taxes that they owe. Some steps to reduce your taxes may be less complex than you expect. For example, you may be able to accumulate tax-free income by contributing money to health savings accounts, putting it aside for the education of your children, signing up for employer benefits like health insurance, and investing in government bonds. If you sell your home, the home sale tax exclusion makes this income tax-free. You can also give investments to your children to reduce your tax burden.
Many individuals prefer to defer the payment of their taxes to a future year. This does not mean that you avoid the obligation of paying taxes, but deferring payments usually means that you will be better off than if you had paid your taxes sooner. You might be able to defer some taxes by putting your earnings in certain types of retirement accounts, such as an IRA. Or you can defer tax payments related to a bonus from your employer if you postpone the bonus.
Tax Deductions and Credits
Most people are familiar with the concept of tax deductions, which reduce the income that may be taxed. Fewer people may be aware of tax credits, which offer a dollar-for-dollar reduction of your tax obligation and thus may be even more useful.
As an individual taxpayer, you can choose between taking a standard deduction or itemizing deductions for items like charitable donations, state taxes, and mortgage interest. Itemizing deductions is only worthwhile if you have many deductions to itemize, since the standard deduction has become much larger under the Tax Cuts and Jobs Act. If you are a business owner, you can apply deductions to many types of expenses related to your business.
Tax credits are constantly expanding, but common examples include child tax credits, child care tax credits, and education tax credits. You may also receive a tax credit for making certain environmentally sensitive purchases.
Adjusting Tax Rate and Filing Status
The range of federal income tax rates extends from zero to 37 percent. Investing in stocks, bonds, mutual funds, and other long-term types of investments can help reduce your tax rate. This is because you will be taxed at long-term capital gains rates on any profits from these investments. The maximum tax rate for a long-term capital gain is 20 percent, which is lower than the income tax rate for taxpayers in all but the two lowest tax brackets.
However, a 3.8 percent Medicare tax often applies to income that is subject to capital gains tax. You will need to pay the extra Medicare tax if you are filing jointly as a married couple with over $250,000 in income or if you are filing separately with over $200,000 in income.
If you have a choice among more than one type of tax filing status, you can consider the pros and cons of each status. This can affect your tax bracket and the standard deduction for which you may be eligible.
