An average American pays about 14.9% of its annual income towards income tax, which translates to about $2.2 trillion. While you cannot avoid paying income taxes, there are specific ways to legally reduce the taxes you owe to the IRS. However, it requires a good understanding of how taxes work and what techniques you can employ to reduce your tax burden.
You can learn about different investment options, deductions, and credits to help you reduce the tax amount. Alternatively, you can hire accountants in Savannah, GA, to help you maximize your tax savings. Hiring professional accountants can provide you with expert guidance and peace of mind when it comes to managing your finances and taxes.
Top tax optimization strategies for individuals
You may have to pay income tax between 10% and 37%, depending on your annual income. However, you can save a significant amount of tax with thoughtful tax planning and the right strategies. Following are some of the most common ways to reduce your tax burden.
Start investing in municipal bonds.
Governments require money to maintain public properties like roads, public schools, parks, etc. The majority of this money is collected by selling the securities in the form of municipal bonds.
While municipal bonds help governments raise money, they also provide tax benefits to buyers. You do not have to pay federal income tax on the interest you earn, which makes them an attractive investment option. Another reason why municipal bonds are so popular is because of the tax-equivalent yield they offer.
Utilize long-term capital gains.
Investing is an essential tool to help your money grow against inflation. Not only that, the long-term capital gains you earn on your investment are also tax-favored. This means that, depending on your annual income, the sale of any asset you have held for more than one year will attract a preferential tax of 0%, 15%, or 20%.
However, if you hold an asset for less than a year, the capital gain tax is charged at the ordinary income tax rate.
Starting a business can be beneficial.
While starting a side business can help you earn some extra money, it can also offer tax advantages. Many of your business expenses can be deducted from the taxes you owe. If you use your house for business, you can even deduct a part of your home expenses utilizing the home office deduction per the IRS guidelines.
However, you must conduct the business to make the profits and claim the deductions under home office deductions.
Use your limits on retirement account contributions.
Your contributions of up to $23,000 to retirement accounts like 401(k) or 403(b) are also tax deductible. For individuals over 50 years, the limit goes further up by $7,500. However, if your employer does not offer a retirement plan, you can still open a traditional individual retirement account (IRA) and get a tax break of up to $7,000 ($8,000 for individuals over 50)
Use your Health Savings Account (HSA) contributions.
If you have a high-deductible health insurance plan, you can use your contribution towards a Health Savings Account (HSA) to reduce the tax liability. The HSA contributions made by payroll are excluded from your taxable income and are tax-deductible with an individual limit of $4,150.
Use the tax credits.
Tax credits are considered to provide the most significant tax benefit as, instead of reducing your taxable income, they reduce taxes dollar for dollar. It implies that with a $1,000 tax credit, you can reduce the tax you owe by $1,000.
For example, the following are some of the most common tax credits individuals can use to reduce their tax liability.
- $2,000 child tax credit for each qualifying child under the age of 17
- Earned income tax credit is meant for lower-middle-income families with a credit limit between $600 and $7,430.
- With the American Opportunity tax credit, you can save up to $2,500 per eligible student for the first four years of higher education.
Final takeaway
With the knowledge and guidance of skilled and experienced tax accountants by your side, you can identify the best options to reduce your tax liability without violating any tax law. Moreover, with a proper tax plan in place, you get to enjoy financial stability without worrying about taxes.
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