If there is one thing that all taxpayers can agree upon, it is the desire to pay less in taxes and keep more of your hard-earned cash where it belongs – in your pocket. With the ever-changing tax laws and so many life-changing events occurring, staying on top of one’s taxes is essential to avoid overpaying.
As a general rule, the IRS will not seek out ways to reduce your taxes for you; therefore, it is the responsibility of you as a taxpayer to educate yourself on how to legally reduce your tax liability. Fortunately, if you take the time to investigate your options, you will discover that there are several ways to pay less in taxes.
Here are some of the ways through which you can reduce the amount of taxes that you pay without risking any trouble from the IRS:
Lower Taxable Income Through Deductions or Offset Taxes With Credits
There are two main ways to reduce your tax liability. The first is to find ways to lower your taxable income through deductions. The more money you make – either earned income or through investment gains – the more money you will owe the IRS. For example, if you are in the 25% tax bracket and take a $100 tax deduction, you will lower your tax bill by $25 (assuming you are itemizing deductions and not using the standard deduction).
The second main way to reduce your income taxes you pay is through tax credits. Tax credits will directly offset your tax bill by the amount of the credit. If you were to take a $100 tax credit, the taxes paid would be $100 lower. Therefore, you must either legally reduce your taxable income through the use of deductions or use various tax credits to lower your tax bill.
Retirement Account Contributions
Make contributions to a retirement account is an easy deduction to lower taxable income, and there are several different ways in which this can be done. If you use a tax-deferred retirement plan, you will see an immediate tax reduction in that you reduce your taxable income. For example, contributions to a traditional IRA or 401(k) are not taxed at the time of contribution, but rather used to lower the taxable income that you report on your income tax return. Contributions to a Roth IRA, on the other hand, are taxed at the time of contribution; however, qualified distributions from the account are not taxed. Both of these options are win-win situations for the taxpayer because you are not only reducing the amount you pay in taxes, but also saving money for your retirement years. The great thing about taking contributing to retirement accounts is that you do not need to itemize deductions to claim them.
Many taxpayers have eligible job-related expenses that they can claim in order to lower the amount that they owe in taxes. Job-related deductions are claimed on Schedule A (Form 1040) and can include unreimbursed expenses such as license fees, office supplies, uniforms, travel and job training. All claimed expenses must be job-related in order to qualify as legal deductions. More information about these expenses can be found in Publication 529. In order to take this deduction, taxes deductions must be itemized on the tax return. Realize that there are times where it is better to take the standard deduction rather than itemize deductions.
Earned Income Tax Credit
According to the government, a whopping 20 percent of taxpayers who qualify for the Earned Income Tax Credit (EITC) do not claim it. If you have not claimed this credit in the past, you may be eligible and not even know it. Qualifications are based on income and the size of family, and for those who are eligible, this credit may reduce taxes by as much as $5,751 (max for 2011 with three or more qualifying children) or qualify you for a refund.
Another win-win situation for taxpayers is to reduce taxes owed by making charitable donations. Whether you are donating cash, clothes or even a car, these donations may be claimed as a deduction. However, it is important to be aware of and avoid being a victim of or participant in any charitable tax scams.
Manage Investments Wisely
With so much happening in the stock market and other investment areas, understanding the best way to manage your investments – including gains and losses – is imperative. This may include offsetting any capital gains with capital losses. When your capital losses exceed your capital gains, you may deduct the amount (up to $3,000) from your taxable income. If your losses exceed $3,000 it is important to remember to carry this loss over to the following years.