Let’s be honest. Nobody actually likes paying taxes. Given a choice, we would all like to pay as little taxes as possible.
While it is not possible to avoid taxes altogether, there are ways in which you can reduce your tax burden to the extent possible.
Here are five strategies that can help you lower your tax bill.
Contribute to retirement accounts
One of the easiest ways to reduce your tax bill is to max out the contributions you make to your 401(k) and IRA accounts. Since these contributions are tax-deductible, you can reduce your taxable income to a significant extent.
Also, by making regular contributions to these accounts, you can build a substantial nest egg for your retirement.
It should be noted that you can only deduct the contributions you make to a traditional IRA account. If you have a Roth IRA account, your contributions are not deductible.
On the other hand, withdrawals from a Roth IRA are tax-free, whereas you will have to pay taxes on the withdrawals from a traditional IRA.
Own municipal bonds
When you buy a municipal bond, you are lending money to the government. Once the bond matures, the government repays the amount you loaned them with interest.
The best part is that the interest paid on your investment is exempt from federal and state taxes.
These bonds are issued by the government and are protected against default risks.
So, despite low interest rates they can be of the best tax-efficient investment options available.
Contribute to a health savings account
If you want to reduce your taxable income, max out the contributions to your health savings account (HSA). If you do not have one, set up an account right now.
Not only are the contributions to your health savings account tax-deductible, but the withdrawals you make are also exempt from taxes, as long as the money is used to pay for qualified medical expenses. Money unspent can be invested as well, making the HSA a kind of “hidden IRA” for some.
Note that you must have a high-deductible health plan to open an HSA.
Claim tax credits
Taking advantage of the tax credits you are entitled to is by far the best way to reduce your tax bill. Unlike a tax deduction, a tax credit does not reduce your taxable income. Instead, it directly reduces the amount of taxes you have to pay. So, it can result in more savings for you.
The tax credits you might be entitled to include:
- Child tax credit
- Child and dependent care credit
- Credit for the elderly or disabled
- Earned income tax credit
- Saver’s credit
- Residential energy efficient property credit
- Health coverage tax credit
- American opportunity credit
Aim for long-term capital gains
The money you invest in stocks, bonds, mutual funds, and real estate can help you reduce your tax burden as long as you hold on to your assets for more than a year.
Long-term capital gains are taxed at a much lower rate than your short-term capital gains, so you can reduce your tax bill considerably by holding your assets for a year or two before selling.
The best part is that if you make $40,400 or less you do not have to pay any taxes on your long-term capital gains.
If you make more, your gains might be taxed at 15% or 20%, depending on your income level.