You get your paycheck and see the nice big “gross” income number on top of the pay stub. Scroll down a bit and you’ll notice that the “net” or actual amount that is deposited into your checking account is significantly smaller. That’s because your earned income gets taxed in many ways – federal, state, Social Security, Medicare and more. Taxes are difficult to avoid, but there are many strategies around to help ward them off a bit.
Here are six top ways to protect your income from taxes.
- Income taxes can be a real drag, but you can take several steps to lower your taxes due.
- Contributing to qualified accounts with pre-tax dollars can defer or exempt some of that income from taxation.
- Business ownership also includes several work-related tax breaks, as well as owning a home or being a student.
- Tax-sheltered income from eligible municipal bonds can also save you from the tax man in April.
If you have savings or investments, there are ways to avoid taxes on the income from those investments. Most municipal bonds are federally tax-free. When you buy an individual municipal bond or a municipal bond fund from your own state, then the interest payments from that income are also tax-free. The downside of municipal bonds may be the lower income than from comparable taxable bonds. Find out by checking the bond’s tax equivalent yield.
Long-Term Capital Gains
Investing can be an important tool in growing your long-term wealth. An additional benefit from investing in stocks, bonds and real estate is the favorable tax treatments for long-term capital gains. When you invest in mutual funds and individual financial assets, own them for longer than one year and then subsequently sell for a profit, you pay a lower capital gains rate on the money earned. The rate may be as low as zero for those in the 10% or 15% tax bracket. This is an excellent strategy to both improve your financial situation and your tax liability.
Start a Business
In addition to creating additional income, a side business offers many tax advantages. When used in the course of your daily business, many expenses can be deducted from your income, reducing your total tax obligation. Especially important tax deductions are health insurance premiums. Also, if you follow the IRS guidelines, you may deduct part of your home expenses with the home office deduction. The portion of your utilities and Internet used in the business may also be deducted from your income.
Max Out Workplace Retirement Accounts
For 2018, you can reduce your taxable income by $18,500 when contributing to a 401(k) plan or 403(b). If you’re age 50 or older, you’re allowed to add $6,000 to the basic workplace retirement plan contribution. Thus, if you earn $100,000 and contribute $18,000 to a 401(k), then only $82,000 of your income will be taxable.
There are still tax breaks if you don’t have a 401(k) or 403(b) at work. Contribute up to $5,500 ($6,500 if you’re over age 50) to an IRA. Depending upon your income, you may be able to deduct some or all of this contribution from your taxable income.
Go for a Health Savings Account (HSA)
With the preponderance of high deductible health insurance plans, an HSA can also reduce taxes. Similar to a 401(k), you contribute money before taxes to an HSA. In 2018, the maximum contribution amount is $3,450 for an individual and $6,900 for a family. This money then grows without the requirement to pay tax on the earnings. An extra tax benefit of an HSA is that when used to pay for qualified medical expenses, withdrawals aren’t taxed either.
Get IRS Credit
There are many IRS tax credits that reduce your taxes dollar-for-dollar. For example, the earned income credit helps lower-income taxpayers reduce their tax bills. The American Opportunity Tax Credit offers a maximum of $2,500 per year for eligible students. There is the saver’s credit for moderate and lower-income individuals looking to save for retirement. Lastly, the Child and Dependent Care Credit helps offset the expenses of raising your children.
The Bottom Line
A few hours spent at IRS.gov and scouring the internet for tax savings may yield hundreds and even thousands of dollars in tax savings. Although it’s important to pay all that you legally owe to Uncle Sam, you’re not required to pay any extra. Researching the tips above should help.