If you’re like most Americans, you’re surely in search of new, creative ways to ease your annual tax burden. Fortunately, there are several ways you can cut your taxes or increase the amount of your tax refund without incurring the wrath of the IRS.
Tax credits and allowable deductions come and go as the IRS alters their rules and regulations from year to year. However, there are a number of ways to trim your taxes that are sure to remain applicable year after year.
How to Pay Less Taxes (Legally)
1. Contribute to a 401k
Your tax due is based on your adjusted gross income, or AGI. The higher your AGI, the more you owe the government. The key here is the word “adjusted,” which refers to the fact that you can reduce this all-important total in a few different ways – and one method is to deposit pre-tax contributions into a 401k or other tax deductible retirement account.
The more you contribute to your 401k, the more you can reduce your AGI and the amount you owe in taxes. And while that money is sitting in your 401k account and hopefully growing every year, you don’t need to pay capital gains tax on it, either. Furthermore, when you withdraw the money after retirement, odds are that you’ll be in a lower income tax bracket than when you deposited it – meaning you’ll end up paying far less in taxes than if you hadn’t tucked it into your 401k.
2. Don’t Pay Off Your Student Loans
It’s often advisable to pay off debts as soon as possible so that you don’t have to pay as much interest. However, in the case of student loans, the interest you pay actually helps you at tax time because you can deduct it from your AGI, thus reducing your taxes.
Eliminate your credit card debt by all means, but pay off your student loans last so that you can wring out every possible penny in deductions. Note that there are limits to how much interest you can deduct; furthermore, your income may affect whether you can use this deduction at all, so check with your financial advisor for specific details.
3. Buy a House
If you’re considering buying a house, realize that having a mortgage can save you a ton of money on your taxes, as mortgage interest is deductible. For the first few years after purchase, practically your entire house payment goes against the loan’s interest – which means you can deduct a huge sum. As a bonus, you also get to deduct the money you pay each year for property taxes. You can even deduct the amount you pay for points, which are upfront fees lenders charge on a mortgage. The higher your tax bracket, the more you can benefit from mortgage-related deductions.
4. Select the Correct Filing Status
Your filing status has a major impact on your tax situation, as this determines both your tax rate and your standard deduction rate. Whatever your personal situation, you are likely to have a choice of two or more filing statuses. If you are married, you can choose between married filing jointly and married filing separately. Single parents can file as single but often can get a better deal on their taxes by filing as head of household.
For example, in 2012 the standard deduction for a single return was $5,950, whereas the standard deduction for head of household was $8,700. The tax rate brackets for head of household are also more generous than those for single filers.
5. Take College Classes
If you have an unexplored interest in Mycenaean pottery or ancient Chinese marketing strategies, pull out your local college’s catalog and sign up for a class. Taking a college course makes you eligible for the Lifetime Learning Credit, and the class doesn’t have to be job-related. If your income is above the phase-out range for this credit, another option is to deduct your tuition and fees.
6. Save Receipts
Charitable donations are a valid itemized deduction, so always get a receipt when you give and so you can be rewarded for your generosity by the IRS. Other itemizable deductions include healthcare expenses, work-related expenses, and taxes paid to other entities (usually state and local governments). You can even deduct some of the costs you incur while job hunting, such as cab fares and employment agency fees.
Save the receipts for all of these expenses, and odds are you’ll end up with more to deduct and a lower tax bill than you’d get if you’d chosen the standard deduction. Note that some deductions must exceed a certain percentage of your income in order to be itemized. For example, healthcare expenses must total more than 7.5% of your AGI to be counted.
7. Double-Check Old Returns
If you missed some juicy deduction or credit on a return within the past three years, you have the option to file an amended return form. You need to fill out a brand new 1040 and also complete the 1040X form, which details the change. Keep in mind that the IRS tends to check amended returns more closely than regular returns, so be very sure that your information is accurate and complete.
8. Have Your Taxes Prepared by a Professional
Not only will an expert be more likely to get you the best possible deal, but you can even deduct your tax preparation fees. Many tax pros offer guarantees so that if it turns out you paid more than you should have, you’ll get a reimbursement from the preparer.
For added security, choose a CPA or an enrolled agent to prepare your taxes. These preparers charge somewhat more than an uncertified agent, but are held to a higher level of competency by their credentialing organization.
Before you start your tax return each year, check for new credits that may apply to you, and review the IRS’s rules for deductions. If you decide to do your own taxes, many tax prep software programs exist that can walk you through your return, and the IRS allows you to e-file individual tax returns at no charge.
Above all, remember that the most important tax-saving measure is to take the time to review your return carefully before you submit it. By taking your time and double-checking your return, you ensure that you will receive the greatest amount of deductions possible.
What other ways can you suggest to save money on taxes?