Taxes are pretty hard to avoid and an unexpected tax bill can mar anybody’s day. Good thing, there are countless tax-saving strategies out there that can save you from drowning with tax liabilities. As such, one of the best ways to pay fewer taxes is by reducing your taxable income.
Does it mean you need to make less money? Of course not! It only means that you need to switch over to certain types of income that the government doesn’t consider taxable or also known as taxable-exempt income. Are you ready to learn some tax-saving strategies that may legally reduce your tax liabilities this 2022? If you are, read on and discover the best tax-saving method for you!
1.) Maximize Your 401(k)
One way to pay less tax is to have less taxable income, and optimizing 401(k)s is among the popular strategies to reduce your tax bills. Why? Because the Internal Revenue Service doesn’t tax what you have directly diverted from your paycheck into a 401(k). From a yearly contribution of $19,500 for 2021, this rises to $20,500 for the year 2022.
Meanwhile, if you’re 50-year-old or up, your catch-up contribution remains unchanged at $6,500 for this year. However, if cash flow won’t let you max out contributions, consider increasing your contribution rate from 1% to 2% for the following years.
2.) Optimize Health Savings Account (HSA) Contributions
A Health Savings Account (HSA) offers three major tax advantages. These are:
- A health savings account (HSA) allows you to make tax-deductible contributions, earn tax-free interest, and withdraw tax-free funds for eligible medical expenses.
- HSAs vary from flexible spending accounts in which you may only carry over a certain amount from year to year.
- There is no limit to how much money you may save in an HSA, and there is no time restriction on when you must use the funds.
For 2022, you can contribute up to $3,650 for self-only high-deductible health coverage and up to $7,300 for family high-deductible coverage. If you’re 55 years old and above, you are eligible to add an extra $1000 to your HSA.
3.) Fund Charitable Giving in 2022 with Appreciated Stock
When making charitable contributions, it is best to gift highly appreciated tax rather than cash. Why? Because it is an itemized tax deduction, the charitable organization won’t have to pay tax on the capital gain. Furthermore, you can then buy the stock back with the cash you would have otherwise donated as an efficient strategy to increase your portfolio’s cost basis.
4.) Develop a Tax Payment Strategy
You should monitor your tax payments if you are paying federal estimated taxes in 2022. With this, it will help you make sure that you exceed 90% of your estimated liability for 2022 or 100% of your tax liability in 2021 to prevent having underpayment penalties. Take Note, estimated tax payments are due quarterly and these are the dates you should be aware of:
- April 18, 2022
- June 15, 2022
- September 15, 2022
- January 16, 2023
5.) Take Advantage of an Asset Location Strategy
To manage your tax liability, use an asset location strategy. Put high-yielding assets like real estate investment trusts (REITs) and taxable bonds into tax-advantaged accounts. Consider taxable accounts for investments that yield lower tax costs, such as municipal bonds and stock index ETFs.
6.) Donate and Repurchase
Giving to charity provides inherent benefits as well as current (and future) tax advantages. Instead of sending cash, you may maximize your charitable giving deduction by providing valued stocks. Charities do not pay taxes on stock sales, thus they receive the full value of the shares as a contribution.
After you’ve donated the securities, you can buy them back at a greater price than when you first bought them. If you sell the same shares again in the future, your capital gains tax base will be substantially larger, lowering your capital gains tax liability.
7.) Check Out Separate Filing Status
Certain married couples may find it more advantageous to file individually rather than jointly. If you match the following conditions, you might consider filing separately:
- Large medical bills, various itemized deductions, or casualty losses have been incurred by one of the spouses.
- The salaries of the spouses are about equal.
Since the adjusted gross income “floors” for claiming the above deductions will be determined separately, filing separately may benefit such couples. Couples filing separately, on the other hand, are denied some tax benefits. In some areas, filing separately might help you save a lot of money on state taxes.
8.) Buy and Hold
Buy and hold is a passive investing strategy in which investors purchase stocks and keep them for a long time, regardless of market fluctuations. Long-term investments are usually taxed at a lower rate than short-term investments.
9.) Consider Tax-efficient Funds
In choosing investments for your non-retirement accounts, there are several factors to consider. One of these is tax efficiency. Your portfolio’s ultimate objective should be to maximize after-tax returns.
Investing in tax-efficient assets, such as index funds, mutual funds, and ETFs (exchange-traded funds), is one approach to reduce the amount of money you lose to taxes. ETFs provide an extra tax benefit. Because of the manner transactions are handled, the ETF may be able to avoid generating capital gains.
Most individuals frequently utilize ETFs as a foundation for some customers’ portfolios because they provide the best of both worlds—low costs and tax efficiency. Take note that index mutual funds follow a benchmark, and their purpose is to equal the performance of the benchmark. These investments may not be what you’re searching for if you want to outperform a benchmark.
10.) Claim a Home Office Deduction
Don’t be scared to claim the home office deduction if you work for yourself or have a side business. The area must be utilized regularly and exclusively for commercial activities to qualify for the deduction. You can deduct one-fifth of your rent and utility expenses if an extra bedroom is utilized completely as a home office and accounts for one-fifth of your apartment’s living area.
11.) Itemize State Sales Tax
An individual who itemizes their deductions can include either their state sales tax or their state income tax on their Schedule A form. If you live in a state without income taxes, the state sales tax exemption is a fantastic alternative.
While the IRS provides a chart for claiming sales tax deductions, taxpayers should remember to include sales tax from any big purchase, such as a car or boat. From all sources, the federal tax deduction for state and local taxes is restricted at $10,000.
12.) Contribute to an IRA
If you don’t have a retirement plan at work, you can get a tax break by contributing to a Traditional Individual Retirement Account (IRA) with up to $6,000 or $7,000 if you’re 50 years old and up. You may be able to deduct some or all of your IRA contribution from your taxable income (depending on whether you or your spouse is covered by a retirement plan at work and how much money you make).
For 2021, you may not be able to have an IRA contribution deduction if:
- You’re covered by a workplace retirement plan;
- You’re married and filing jointly; and
- Your modified adjusted gross income is $129,000 in 2022
Furthermore, you still have until the tax-filing deadline to contribute to an IRA for the previous tax year, which allows you to have extra time to take advantage of this strategy.
13.) Choose Tax-friendly College Saving Options
A 529 plan is a tax-advantaged savings plan designed to help pay for your education. A 529 college savings account can be used to save money for higher education for a beneficiary such as your children, grandkids, friends, or even yourself.
You can contribute after-tax funds to a 529 savings account, which will grow tax-deferred and allow you to make tax-free withdrawals for qualified educational expenses. Keep in mind that in 2022, there might be gift tax consequences if your contributions plus any other gifts you have given to a particular beneficiary exceed $16,000.
14.) Fund your Flexible Spending Account (FSA)
The Internal Revenue Service (IRS) allows you to channel tax-free dollars directly from your paycheck into your flexible spending account (FSA) each year. Thus, if your employer offers an FSA, it is best to grab it and take advantage of this opportunity to lower your tax bill.
- In 2022, the limit of FSA rises to $2,850 from $2,750 in 2021,
- You’ll have to use the money on your flexible spending account during the entire calendar year for dental and medical expenses. However, you might also be able to spend it on related everyday stuff such as pregnancy test kits, bandages, acupuncture, and breast pumps for yourself and your eligible dependents.
- Some employers might let you carry money over to the next calendar year.
15.) Subsidize your Dependent Care Flexible Spending Account
Subsidizing your dependent care FSA is another way to reduce your tax bill—if your employer allows you to take advantage of it. In fact, in 2021, the IRS allows an exclusion of $10,500 on your pay when your employer diverts it on a dependent care FSA account; thus you don’t have to pay taxes on this money.
16.) Write Off Business Travel Expenses, Even While on Vacation
If you combine a vacation with a work trip, you can save money on your holiday by deducting the percentage of expenditures spent on business. This might include flights and a percentage of your accommodation bill, depending on how much time you spend on the business. Consult a tax expert for assistance with this computation.
17.) See if You Qualify for an Earned Income Tax Credit (EITC)
You might obtain a refund from the government even though you aren’t obligated to pay federal income taxes. For the tax year 2021, the Earned Income Tax Credit (EITC) is a refundable tax credit of up to $7,000.
The EITC is calculated using a formula that takes income and family size into account. The credit’s income limitations vary from $21,430 for single filers without children to $57,414 for married couples filing jointly (those who have three or more children).
18.) Hold Off Bonuses or Other Earned Income
If you are due a bonus at the end of the year, you may be able to hold receiving it until January. This allows you to defer paying taxes (other than the percentage withheld) for another year. If you’re self-employed, wait until after the new year to submit invoices or bills to clients or consumers.
You can defer part of the tax here, too, if you meet the estimated tax requirements. If you are in a lower tax bracket the next year, you may be able to save money on taxes. The amount subject to social security or self-employment tax does, however, grow each year.
19.) Divide Assets Among Accounts
To maximize after-tax returns, you can pick tax-efficient assets, but you must also choose the correct sorts of accounts to store your investments in. Asset placement is a strategy of lowering taxes by splitting your assets across taxable and nontaxable accounts.
Consequently, you put non-tax efficient investments in tax-deferred accounts and tax-efficient investments in taxable accounts. Most financial advisors that work with their clients include their clients’ tax-efficient asset placement strategies into their personalized financial plans so that they may keep more of their earnings.
20.) Accelerate Capital Losses and Defer Capital Gains
If you have assets with an accumulated loss, it may be prudent to sell them before the end of the year. You can deduct capital losses up to the number of your capital gains + $3,000. If you want to sell an investment with an accumulated gain, it may be advisable to wait until after the end of the year to avoid payment of the taxes until the following year (subject to estimated tax requirements).
The maximum capital gains tax rate is 20% for most capital assets held for more than 12 months (long-term capital gains). However, don’t forget to think about the asset’s investment potential. To maximize the economic benefit or minimize the loss, it may be advantageous to keep or sell the item.
21.) Get the Right Investment Timing
Mutual funds are required to disperse a particular amount of their net income each year, and the income distribution is normally covered by the investors. The length of time you’ve had the account isn’t taken into account. Check the distribution date before buying mutual fund shares to ensure you don’t buy them too close to the distribution date.
What are the 3 basic tax planning strategies?
While there are numerous ways to help reduce tax liabilities (including the strategies mentioned in this article), but, it primarily involves three basic tax planning strategies, these are:
- Reducing your overall income;
- Taking advantage of certain tax credits; and
- Increasing your number of tax deductions for the entire year.
What are the ways to reduce tax liabilities?
If you want to reduce your tax liabilities you must cut out some of your taxable income. On top of that, maximizing your Health Savings Account (HSA) and Individual Retirement Account (IRA) are also among the smart ways to legally reduce the taxes you have to pay.
How can I reduce my taxable income?
One of the best ways to pay fewer taxes is by reducing your taxable income. The best way to do this is to lower the income that the government views as taxable. It doesn’t literally mean making less money, you just need to switch over to certain types of income that aren’t taxable this is called tax-exempt income.
In terms of income tax preparation, your personal spending plan or how you spend your budget is vital on top of the strategies listed above. As such, being aware of your present and future spending plans can help you determine the resources you’ll devote to these tax-saving tactics.
It’s simple to build a list of prospective tax-saving strategies. However, the real challenge is following through and putting those plans into effect. This is when having a personal spending strategy comes in handy. You’ll be able to confidently plan for future tax seasons by determining how much you can afford to shift to tax-advantaged accounts and purposes that will help you achieve your life objectives.