Taxes feel like a burden, especially to the ordinary citizen. At the very least, it is an inevitable responsibility that hinders whatever strategy you have in improving your financial condition. Although it sounds illegal, there are strategies and ways to reduce your tax bills in a legally acceptable manner.
By lowering the amount you have to remit to the Internal Revenue Services (IRS), you get to keep more of your income to yourself. You can then use these savings for reinvestment or any other method that would speed up your process of building wealth. To get you started, here are five ways to slash your tax bill legally:
1. Adjust your Form W-4
If you’re looking to achieve financial freedom by making conservative estimates on your net or take-home pay, you can actually adjust the tax withheld from every paycheck you receive. For common-law employees or those who regularly receive income from an employer, a Form W-4 is usually completed and filed with the IRS to indicate the tax status from this employment arrangement.
As an employee, you can instruct your employer on how much tax will be withheld from your pay. This way, you can deduct more from your salary and receive less take-home pay. While it sounds disadvantageous, it actually prevents you from underestimating your taxes and getting surprised with your bill once tax season arrives. Better yet, by raising your withheld taxes and not having additional taxes at the end of the year, most of the excess taxes withheld from you will be refunded. Conversely, you can also reduce your withholding tax if you need more from your paycheck, although you might be required to pay more by the end of the fiscal year.
2. Making charitable donations
This is a strategy that businessmen and wealthy people often use to diminish their taxes year after year. Now that a lot of people are earning large sums of money from cryptocurrency and NFT trading, you might want to consider the rich man’s strategy of making donations. Generally, giving a portion of your wealth to charitable and non-profit organizations qualify you for different tax deductions, breaks, and even exemptions.
For example, a charitable lead annuity trust is a fund that lets you regularly donate to a chosen charity or nonprofit for a set number of years (or your entire lifetime). At the end of the period, the rest of the assets in this fund is distributed to the other non-charity beneficiaries. This usually pertains to your family such as descendants and heirs.
This makes it a perfect way to transfer your wealth to your family, help charities, and qualify regularly for various tax deduction purposes. However, it is not absolute and there is a certain annual donation amount needed for you to qualify. Still, once you do, it essentially turns into a virtually tax-free channel for moving your wealth.
3. Reduce your taxable income
The most straightforward way to reduce tax bills is to reduce your taxable income. However, while it sounds simple, it doesn’t necessarily translate to earning less. There are different ways with which one can reduce their taxable income. Below are some of the popular options:
Start saving in your 401(k)
For employees, a 401(k) is a retirement saving and investment plan that is usually offered by an employer. Funding for this, however, comes from your paycheck and is regularly deducted every payday. Also, depending on the employer, the company may also match your contributions as a part of its benefits package.
The great part is that whatever segment of your salary goes into the 401(k) is automatically deferred. It is not tax-exempted. This means that the amount you put into your plan is not taxed until the time you withdraw your money. While it sounds negligible, remember that your tax rate today is usually significantly higher than your tax rate by the time you’re old enough to withdraw your funds.
Invest in IRAs
Whereas a 401k is company-sponsored, an individual retirement account (IRA) is something you get for yourself and entirely pay for it. There are two types of IRAs: Roth and traditional. For traditional IRAs, there are certain criteria for identifying tax-deductible contributions. It includes your income and your existing coverage with other retirement plans for you and your spouse.
By saving funds for your children’s education, you also shave off your tax bill. An educational fund, technically known as a 529 plan, is a tax-advantaged savings plan. Essentially, if it’s used for any qualified educational expenses–college, apprenticeships, K-12–for a designated beneficiary, you get a variety of tax breaks.
4. Hold on to your medical receipts
Another method for slashing tax bills is something most people forget or are simply unaware of. Your medical expenses are tax-deductible payments, provided you can file for them. The IRS even offers a comprehensive list and criteria for checking if your particular health-related expense can be filed for a tax deduction. For starters, qualified medical expenses that exceed 7.5% of your adjusted gross income for the taxation year are tax-deductible.
Medical expenses cover a wide range of services aside from medical and dental. It may cover vision, acupuncture, ambulance costs, breast pumps and maternity supplies, chiropractors and crutches, and more.
There are perfectly legal strategies to reduce your tax bill for the coming fiscal year. Remember that these strategies are not inherently designed for people to “cheat” the system. A common theme among these tax breaks and deductions is to encourage the public to save and be more responsible with their finances. By following the strategies listed above, not only do you save a lot of money but you also learn the mindset and practices that not only qualify you for discounts but also help you accelerate your wealth-building in general.