What Are Some Ways to Minimize Tax Liability?

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What Are Some Ways to Minimize Tax Liability?

Few people want to pay higher taxes. Understanding and accurately calculating the tax credits and deductions that we are entitled for might be the difference between paying more money at tax time and getting a nice refund. Here are four easy strategies to reduce your tax obligation.

Key Takeaways

  • The key to lowering your tax burden is to reduce the percentage of your gross income that is subject to taxation.
  • Consider raising your retirement savings.
  • Investing pre-tax cash in an employer-sponsored retirement plan, such as a 401(k), is a simple method to lower your taxable income for the year.
  • If you sell a losing investment, you may use the loss to offset other income.
  • If you itemize your deductions, donating to charity might lower your yearly tax burden.

Increase Your Retirement Contributions

Your income tax is calculated based on your gross income, and for many of us, the simplest method to minimize that amount is to contribute to an employer-sponsored retirement plan or an independently owned conventional IRA.

Following the passing of the Setting Every Community Up for Retirement Enhancement Act (SECURE) of 2019, the age limit for contributing to a conventional IRA was eliminated. Seniors may now contribute to their IRA accounts forever.

The new legislation also increased the age at which seniors must begin taking required minimum distributions (RMDs) from their 401(k) and traditional IRA accounts. Previously, RMDs had to be taken at the age of 712. That age was raised to 72 years with the passing of the SECURE Act. Depending on a person’s tax bracket when they begin withdrawing assets, the transition to accepting distributions may have an effect on taxes.

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Employer-sponsored plans, such as a 401(k) or 403(b), enable you to contribute pre-tax cash to your account up to a specific limit. The maximum for 2021 is $19,500 ($20,500 for 2022). Anyone over the age of 50 may contribute an extra $6,500 as a catch-up payment, bringing the total for 2021 and 2022 to $26,000 and $27,500, respectively.

Contribute to Employer-Sponsored Plans

Traditional 401(k) or 403(b) plan contributions are made via regular paycheck withholding and provide a direct dollar-for-dollar decrease in total taxable income. The Roth 401(k) or Roth 403(b) plan, which does not give an upfront tax advantage but does allow for tax-free withdrawals later on, is another form of these programs.

If you don’t have access to an employer-sponsored plan, consider a regular IRA instead. Your contributions will be made using pre-tax monies, reducing your taxable income for the year and, eventually, your total tax burden.

Your contributions for 2021 and 2022 cannot exceed $6,000, with an extra $1,000 permitted for individuals aged 50 and over. A Roth IRA, like 401(k) and 403(b) plans, does not provide an immediate tax advantage.

Profit From Investment Losses

Selling assets that have lost value since you bought them may also help you lower your tax burden for the year, a method known as tax-loss harvesting. These investment losses may be deducted from your investment earnings or other income each year up to a specific amount. This limit is imposed by the Internal Revenue Service (IRS) at $3,000, or $1,500 if you’re married filing separately.

Furthermore, any sum not used this year may be carried forward to future years, lowering your taxes. In contrast, deferring the sale of an appreciated asset might help you avoid paying taxes on the gain, particularly if your taxable income is already substantial.

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Your charitable donations over the year may decrease your taxes if you itemize deductions.

Donate to Charity

Contributions to qualifying charity organizations may potentially decrease your taxes if you itemize deductions on your tax return rather than accepting the standard deduction. Contributions may be made in cash or in the form of products, such as secondhand home items. However, any contribution worth more than $250 needs a receipt in order to be considered a legal deduction.

For further information on these and other tax-cutting options, it’s frequently a good idea, and well worth the money, to visit a CPA or other educated tax professional.

Advisor Insight

Sona Financial, LLC, Minneapolis, Minnesota, Mark Struthers, CFA, CFP®

You may start a health savings account (HSA) if you have a high-deductible health insurance plan; contributions and payouts are tax-free when utilized for medical costs. The same is true for 529 plans, which are utilized for educational costs. Taxes on Series EE savings bond interest may be postponed for 30 years, or until the bonds are redeemed. Within gift-tax restrictions, you may avoid paying taxes on valued assets by donating them to someone. Hold significantly taxable assets in tax-deferred retirement accounts wherever feasible. Just make sure you’re not passing up fantastic investing opportunities or tactics to avoid paying the IRS. Many consumers will reduce their tax burden at the expense of good financial planning. The tax tail is wagging the investing dog.

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