An unexpected tax bill is not only enough to ruin your day, but it can also set you off your financial goals. For people with expendable income, taxes might not matter much, but for the majority of wage earners, big taxes could mean less budget for other essential expenses.
While the amount you pay is based on which bracket you fall under, there are still plenty of legal ways to reduce your expected tax bills. The key is to itemize rather than to settle with the standard deduction. This process may require extra time and effort, but the savings you’ll enjoy will be worth it in the long run.
So if you want to cut your tax bills and protect your hard-earned income the legal way, here are some strategies you can follow:
1. Take advantage of tax credits
A tax credit is an amount of money that you can subtract from the income taxes you owe. And this credit is obtained dollar for dollar, making it a better saving strategy than a tax deduction. There are many ways you can get tax credits, including buying a hybrid car, installing solar electricity panels or water waters to your home, and other home energy improvements. You can also obtain tax credits from child care and education.
You can even apply for an Earned Income Tax Credit, and depending on your marital status and the number of children you have, you can enjoy below zero taxes and even get refunds. If you’re a veteran, you can also qualify for several tax credits and benefits. So if you need cash, you can take out a VA loan or apply for a tax break to ease your financial burden.
2. Divert funds to your retirement plan
Stashing cash in your retirement plan is simply the best way to reduce your taxable income. If you have an employer-sponsored plan like a 401(k) or 403(b), you can contribute up to $19,500 in 2021. If you’re 50 or older, you can catch up on your contributions and put away up to $6,500. These contributions are made pretax through paycheck deductions, making it a direct way to cut your tax bill.
If you don’t have this option, an individual retirement account (IRA) is a smart alternative. It allows for a maximum contribution of $6,000 in 2021, with a catch-up provision of $1,000 for people over 50. Essentially, the higher your contributions are, the more tax deductions you’ll enjoy.
3. Fund your FSA
An FSA or Flexible Spending Account is like a savings account typically reserved for unexpected out-of-pocket medical expenses. The money you put into this account is non-taxable, which means you get to keep the money that would’ve otherwise gone to taxes. Some employers might offer this option, and it works by funneling a portion of your salary pretax into your FSA every year with a limit of $2,750.
So if this option comes up, make sure to take advantage of it. Keep in mind that the money in your FSA has to be used during the calendar year for health care expenses and related purchases like medications, bandages, pregnancy test kits, and so on.
4. Start a college fund
If you have kids, it’s important to start planning for their higher education as early as possible. College tuition fees and expenses can be hefty, so setting up a college fund is necessary to avoid taking out student loans. Other than it being a wise financial move, it can also help reduce your tax payments.
5. Document your medical expenses
If you’ve been hospitalized or obtained costly medical or dental treatment, be sure to keep the receipts. You can enjoy tax deductions from qualified expenses that are more than 7.5% of your adjusted gross income for that tax year.
6. Open a health savings account
Unexpected medical bills can quickly impact your financial status, as medical insurance plans only cover as much. On top of hospitalization fees, you could come across other expenses that your insurance plan doesn’t cover, like professional fees and medications. By opening a health savings account or HSA, you’ll not only be able to save for future medical and dental costs, but you’ll also qualify for tax benefits, just as long as you use these funds to pay for qualified medical expenses.
7. Donate to charity
It might be hard to give away your money when your finances are tight, but consider this a tip if you make it big in the future. Keep your donation receipts and file them so you can get tax credits and deductions to help reduce your federal and provincial income taxes. The higher amount you donate, the more tax credits you’ll receive.
Taxes are indeed inevitable, but they don’t always have to be stressful and limiting. Follow these steps and save a portion of your hard-earned money for more important things like holidays and your dream home.