In 1979, I got my first real paycheck from my first real job after graduating college. I remember opening the envelope in my living room ‘ and immediately going in to shock when I saw the amount. It was 35% LESS than they promised to pay me. After picking myself up off the floor, I studied the pay stub carefully and it then it all came clear. That was the day I learned about income taxes.
Since then, I’ve done the best I could to legally reduce that burden whenever possible. Here are seven of the best income tax hacks there are, in my experience.
7 ways to reduce your tax burden
1. Contribute to your retirement accounts
This is obvious but it is so important that it bears repeating. Max out your contributions to your retirement plans. Do this even if your employer provides no match. Unless you are contributing to a Roth IRA or 401k, the contributions reduce your taxable income, grow tax-deferred, and potentially can provide all you need for a sweet retirement.
If you are holding back because you think the plan is no good, consider changing your investment strategy or talk to the plan administrator about your concerns. Your retirement account contributions are simply too good a tax reduction tool to forgo.
2. Rethink investing
If you are saving money outside of your retirement plans, those accounts are subject to income tax. That’s the bad news. The good news is that you can shift your investment strategy in order to take advantage of long-term capital gains treatment rather than be subject to short-term capital gains.
Since long-term rates are much lower, this can keep serious dollars in your pocket. And while we’re on the subject of investing, remember to keep good records when it comes to basis. If you own funds that reinvest dividends and capital gains, that increases your cost basis and reduces your tax burden when you eventually sell the holding.
3. Travel smart
If you are an employee, you may be able to deduct certain travel expenses if they are not reimbursed by your employer. Those include travel from your office to remote locations (not from your home to the office). Also, if you are temporarily away from home, you can deduct travel and some of your food and lodging. Again, this assumes your employer is not reimbursing you, of course.
If you travel for business and pleasure, you can deduct the part of the trip that is related to business. If your main reason for travel was business, you get to deduct the transportation cost. If your main purpose was to party with friends and family and take in the sights, you can only deduct the costs that are directly related to your job.
If you are self-employed, the above still applies, but you have a host of additional travel tax perks. Study up and take advantage of them.
4. Get a tax break for health costs
Even if you don’t itemize deductions, you can contribute to and get a deduction for HSA (Health Savings Account) deposits. The cool thing is this money grows tax-deferred and belongs to you. If you use the money for qualified health costs, the withdrawals are tax-free. If you withdraw funds for other reasons, those withdrawals will be taxable, but you can keep the money in the HSA and grow tax-deferred until you need it.
5. Open your own business or side gig
If you have self-employment income, you can take advantage of a potpourri of tasty tax treats. Those include a home office deduction and business-related expenses, like dues, memberships, and supplies. Anything needed to run your business can be used as a deduction.
In addition, you may be able to take advantage of additional retirement plans if you are self-employed. The big benefit here is that they provide greater contribution limits, which means lower taxes and a more comfortable retirement down the line.
6. Claim your tax credits
There are a number of tax credits you can claim if you’re eligible and they are very powerful, as they reduce your tax liability dollar for dollar. For example, if you get a tax credit for $2,000 and would otherwise owe $5,000 in tax for the year, the tax credit reduces your tax liability down to $3,000.
If your Modified AGI is less than $80,000 ($160,000 for joint filers) you can claim up to $2500 in tax credits for an eligible student under the American Opportunity Tax Credit. If your MAGI is $65,000 ($135,000 filing jointly), you can claim the lifetime learning credit. That can reduce your taxes by up to $2,000 per year if you have an eligible student. Just keep in mind that you can’t claim both of these credits for the same student during the same year.
Other tax credits include Earned Income Tax Credit, Child and Dependent Care Credit, Advanced Premium Tax Credit and the Savers Credit. Spend a few minutes on the IRS site to learn more about how you can qualify.
7. Max out other deductions
If you don’t itemize deductions, consider doing so — you might be able to save big on taxes. The following is a partial list of potential deductions you may be able to take advantage of:
- State sales tax or state income tax ‘ you choose
- Health insurance premiums
- Charitable gifts
- Babysitter to watch the kids (if you are out volunteering for a recognized charity)
- Unusual business expenses
- Expenses associated with a job search in your current field
There plenty of other methods to cut your tax bill. In my experience, if you are serious about reducing your tax liability, first educate yourself, then go out and find the best CPA you can. They may suggest other tactics that save you even more money. Alternatively, they may explain how not taking certain tax deductions may work in your favor.
Taking the time to understand how the tax code works and getting the soundest advice you can is the best way to make sure Uncle Sam doesn’t put his hand in your pockets any more than necessary.