How to Pay Less Taxes Each Year
Many people work hard all year long, sometimes barely making ends meet only to find out you OWE more taxes once you file your 1040 individual income tax return with the IRS. Although this is not ideal, let’s talk about some strategies you can implement TODAY to help your situation going forward. Here are several strategies you can implement to lower your taxable income which means a decreased amount due to the IRS or a higher tax refund:
1. Contribute to a 401(k), 403(b), 457 Plan or Individual Retirement Account (IRA)
Saving money for retirement provides current and future benefits. The current benefit of contributing to a retirement plan is that you are decreasing your taxable income. The future benefit is you are saving money for retirement for when you decide to stop working. In 2021, an employee can contribute a maximum of $19,500 (or $1,625/month) to a 401(k), 403(b) or 457 Plan. If you’re over the age of 50, the annual contribution limit is increased. IRA contribution limits are different from standard retirement plans and can seem more complex. You can click here to get more information about the IRS guidelines around IRA contribution limits.
2. Contribute to a Health Savings Account (HSA) or Flexible Spending Account (FSA)
Contributions to tax a deferred savings account for health, dental and vision expenses can also provide current and future benefits. Putting money aside in either a Health Savings Account or Flexible Spending Account is beneficial, but you will have to decide which is better for you and your family. HSA’s are typically paired with High Deductible health plans and the savings balance rolls over each year while FSA’s are made available by your employer, but you must use all the money within the same calendar year. HSA plans have become more popular than FSA’s because any unused funds are kept in a tax deferred savings account that does not expire at the end of the year. The maximum contribution to an HSA in 2021 is $3,600 for individuals and $7,200 for a family. For FSA’s, the 2021 max is $2,750.
3. Student Loan Interest Payment Deduction
As many of you can attest, the cost of higher education is steadily increasing which is resulting in more college graduates in student loan debt. After graduation, the payments made towards your student loan can benefit you during tax time. You can reduce your adjusted gross income by up to $2,500 in student loan interest paid during the year. There is an income phaseout depending on your filing status so it’s best to begin making payments towards your student loans as soon as possible before your income exceeds the income thresholds. If you become ineligible for the student loan interest deduction due to the income phaseout, you could find yourself making payments on your student loans and not receiving the benefits of the tax deduction.
Just to provide an example of how this deduction can help, if you are able to claim the entire $2,500 deduction and are in the 22% tax bracket, your tax bill could decrease or your refund could increase by up to $550.
4. Be Sure to Use the Correct Filing Status
Your filing status is important because it will determine your tax rate and the amount of your standard deduction. The tax rate and standard deduction for a taxpayer with a single filing status is not as favorable as a taxpayer with the head of household filing status so selecting the correct status is especially important
Here are filing statuses and associated standard deduction amounts for 2020:
|Filing Status||2020 Standard Deduction|
|Single/Married filing separate||$12,400|
|Head of household||$18,650|
|Married filing jointly||$24,800|
|Qualifying widow or widower||$24,800|
As you can imagine, there are rules around which filing status is correct and it changes based on your situation. You can open IRS Publication 501 for more information.
5. When To Use Itemized Deductions Instead of the Standard Deduction
Depending on your filing status, itemizing your tax deductions instead of using the standard deduction can be more beneficial. The following expenses incurred during the tax year can be included in itemized deductions:
6. Have a Professional Prepare Your Taxes
If you have a simple tax return, using a free online tax solution to prepare your tax return can save you some money in tax preparation fees. For more complex tax situations, finding a tax expert could help you find tax saving opportunities.
Experienced tax preparers may prove to be more costly than less experienced preparers but like most professionals, the price is sometimes linked to the quality of services received. At Rocket Tax & Professional Services, we pride ourselves in making sure each client receives great service at an affordable price. The average price of a tax return at our firm is between $200 - $250 for individuals.
We hope these tips help to put you at ease during tax time and if you ever have any questions, please be sure to reach out to Rocket Tax & Professional Services for more information. Call us at 713-900-9366 now or click here to request a consultation.