Wouldn’t you like to lighten your tax load? I can’t imagine anyone who would not relish that chance. 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 Congress makes changes to tax law from year to year. However, there are a number of ways to trim your taxes that may remain applicable for a while, depending on legislative action.
How to Pay Less in Taxes (Legally)
1. Contribute to a 401k or a Traditional IRA
Adjusted gross income (AGI) is the baseline for the calculation of your tax due. The higher your AGI, the more you can expect to owe the government. But 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 pretax contributions into a 401k or other tax-deductible retirement account, such as a Traditional IRA.
The more you contribute to your 401k, the more you can reduce your AGI and the amount you owe in taxes. In 2017, the maximum IRA contribution is $5,500, and the maximum 401k contribution is $18,000, for anyone under age 50. If you are 50 or older, there is a “catch-up” provision that allows you to 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 each year, you also don’t have to pay capital gains tax. You will have to pay income tax on the funds when you withdraw them, but you may be in a lower income tax bracket when you turn age 70.5 (when you must take required minimum distributions), and will therefore pay a lower tax rate on the withdrawn funds than you would pay now.
2. Don’t Pay Off Your Student Loans
It’s often advisable to pay off debts as soon as possible to avoid high interest rates, and because the interest is not deductible on your taxes. 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 because of the high interest rates, but if you can’t pay off your student loans in a lump sum, take advantage of the interest as an adjustment to income to lower your AGI by as much as $2,500. This is the limit for deductible student loan interest. Furthermore, your income affects whether you can use this deduction at all. For the 2017 tax year, you can deduct up to $2,500 in student loan interest if your modified AGI is $65,000 or less ($135,000 if married filing jointly).
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 ($165,000 if married filing jointly), 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.)
Remember that student loan interest is an adjustment to income, reducing your taxable income by as much as $2,500. If you are in the 25% tax bracket, that could mean as much as $625 in tax savings.
3. Buy a House
If you’re considering buying a house, realize that having a mortgage can save you 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’ll have a sizeable deduction.
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 up-front fees lenders charge on a mortgage. The higher your tax bracket, the more you can benefit from mortgage-related deductions. For example, if your mortgage interest and property taxes total $14,000 for the year, and you are in the 25% tax bracket, your tax savings would be $3,500.
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 get a higher standard deduction if they qualify to file as head of household.
For example, for the 2017 tax year, the standard deduction for filing as single is $6,350, whereas the standard deduction for head of household is $9,350. 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 academic or hobby interest, 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. A deduction merely reduces the dollar figure on which your tax is calculated. The credit is limited to 20% of the first $10,000, or $2,000. For 2017, this credit begins to phase out when your AGI exceeds $56,000 ($112,000 if married filing jointly).
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 itemized deductions include health-care expenses, unreimbursed 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 you may well end up with more to deduct and a lower tax bill than 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, health-care expenses must total more than 10% 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. You need to fill out a brand new 1040 and also complete Form 1040X, which details the changes. Keep in mind that the IRS tends to check amended returns more closely than regular returns, so be 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 if you itemize deductions. Some 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 may charge more than a noncredentialed preparer, but they are held to a higher level of competency and require continuing education by their credentialing organization, which could mean a larger refund for you. You can find an enrolled agent in your area by a zip-code search of the IRS’s database of credentialed preparers.
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 have an “interview” mode to walk you through your return, and the IRS allows you to e-file some 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 and avoid costly mistakes.
What other suggestions do you have for saving money on taxes?