If you’re like most Americans, you may be in search of new, creative ways to ease your annual tax burden. Fortunately, there are several things you can do to 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 its rules and regulations from year to year. However, there are a number of ways to trim your taxes that are likely to remain applicable for a while.
How to Pay Less in Taxes (Legally)
1. Contribute to a 401k or IRA
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 – one method is to deposit pre-tax contributions into a 401k or other tax-deductible retirement account, such as an IRA.
The more you contribute to your 401k, the more you can reduce your AGI and the amount you owe in taxes. In 2016, the maximum IRA and 401k contribution limits are 5,500 and $18,000 respectively for anyone 49 years of age and under. Anyone 50 and older can add an additional $1,000 to the IRA limit and an additional $6,000 to the 401k limit.
And while that money is sitting in your retirement account and hopefully growing every year, you don’t need to pay capital gains tax on it either. You do have to pay income tax on the funds when you withdraw them, but you may be in a lower income tax bracket when you retire, and therefore pay a lower tax rate on the withdrawn funds than you would now.
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 at tax time because you can deduct it from your AGI.
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 affects whether you can use this deduction at all. For the 2015 tax year, you can deduct up to $2,500 in student loan interest if your modified AGI is $65,000 or less.
If you make more than that amount, you may still be able to deduct a portion of your student loan interest as long as your modified AGI is less than $80,000, at which point the deduction phases out completely. (Modified AGI is similar to AGI with the addition of certain deductions, such as IRA contributions, qualified tuition expenses, and student loan interest.)
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, since mortgage interest is tax-deductible. For the first few years after purchase, most of your house payment is interest on the mortgage – 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 can often get a better deal on their taxes by filing as head of household.
For example, for the 2015 tax year the standard deduction for a single return is $6,300, whereas the standard deduction for head of household is $9,250. 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. The credit is preferable to a straight deduction since it reduces the tax you owe dollar for dollar, whereas a deduction merely reduces the dollar figure on which your tax is calculated. 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 if made to an IRS-recognized charity, so always get a receipt when you give so you can be rewarded for your generosity at tax time. 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 your receipts for all of these expenses, and odds are you’re going to 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 10% of your AGI to be counted, or 7.5% if you are or your spouse is 65 or older.
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 is an expert 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 get a reimbursement from the preparer.
For more complex tax situations, consider a CPA or an enrolled agent to prepare your taxes. These preparers charge more than an uncertified agent, but are held to a higher level of competency by their credentialing organization, which could mean a larger refund for you.
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 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 double-checking your return, you ensure that you’re going to receive the greatest amount of deductions possible.
What other ways can you suggest to save money on taxes?