Want to save money on taxes? Here are four tips that can cut your tax bill and save real money at tax time. Everyone has to pay taxes, but there’s no need to overpay the IRS.
Saving money on taxes can be as simple as using tax preparation software or hiring an accountant, but the real tax savings comes from long-term thinking. One way to shrink a tax bill is to take advantage of government incentives that encourage healthy saving, as with 401Ks or IRAs. Other tax incentives include investing in education, living green, giving to charity and starting a business. Still other tax breaks exist simply to help those in need.
Save Money on Taxes by Getting Help
Tax preparation software, like TurboTax.com, HRBlock.com, and TaxAct.com, can find tax savings that might otherwise be missed. These tax software packages ask diagnostic questions to build a picture of the user’s financial situation. They then run the resulting data through their stored banks of over 2,000 IRS tax forms, schedules and sets of instructions. This way, they arrive at the biggest tax refund allowable by law.
What about accountants? Live tax help in the form of an accountant may seem pricey, but H&R Block, one of the largest tax prep firms in the U.S., offers personal tax preparation around the country at reasonable rates. Their price for both state and federal tax preparation and filing in New York City is around $160.
A tax professional can sometimes go a step further than tax software by suggesting ways to alter financial habits to decrease tax liability in future years. Generally, these suggestions involve the kinds of savings plans, deductions and credits outlined below.
Save Money on Taxes by Saving for Later
Saving money can decrease tax liability, and there are several ways to make it work. The U.S. government wants to encourage saving, and tax breaks are its main method of doing so.
For example, Jane is single, doesn’t itemize deductions and has no children. She has an IRS adjusted gross income (AGI) of $35,000. She contributes $5,000 to a combination of the tax free savings plans detailed below. As a result, her AGI drops by the same amount. Her new AGI is $30,000, saving her $743 in taxes for the year. She’s also saved some money for the future, which is never a bad thing.
401Ks. These are retirement plans offered through employers. The money an employee puts into a 401K isn’t treated as income by the IRS until it’s withdrawn, usually during retirement. This means it lowers the employee’s taxes for the year, as in the example with Jane, above. Until it’s needed, the money in a 401K can be invested tax free in a variety of ways. Another bonus is, employers often contribute matching funds to 401Ks, increasing the amount of money in them. 401Ks carry an annual limit on tax free contributions, which in 2015 was set at $18,000 for individuals.
IRAs. An IRA is another type of retirement fund. As with 401Ks, traditional IRAs reduce taxable income. IRAs are different from 401Ks because they don’t need to be set up through an employer. IRAs also have lower annual contribution limits 401Ks. In 2015 IRA contribution limits are set at $5,500. See the IRS video below for more information on IRAs.
College Savings. Contributions to college savings plans, also known as 529 plans, are also tax exempt. Prepaid Tuition Plans let parents or grandparents lock in tuition at today’s rates. Traditional College Savings Plans don’t lock in tuition rates but can be invested in mutual funds to try to grow the balance.
Health Savings Accounts. People with high-deductible health insurance policies can put their money into Health Savings Accounts (HSAs) without it being taxed as income. The contribution limit is the same as the policy’s deductible.
One nice feature of HSAs is that there’s no need to itemize deductions to take advantage of the tax savings. Another? If someone other than the account holder makes a contribution, the account holder still receives the tax benefit. This means family members and employers can contribute to HSAs as gifts or compensation, tax-free for the beneficiary. Finally, HSAs travel with employees, rolling over from year to year and going with an employee who changes jobs.
Flexible Spending Accounts (FSAs). These are very similar to 401Ks in that they’re set up through an employer and they reduce taxable income. Unlike 401Ks however, FSAs aren’t for saving for retirement. Instead, employees use them to pay future medical costs or childcare costs. Other differences are, for 2015 the limit on Medical FSAs is $2,550, and on Dependent Care (childcare) FSAs is $5,000. Traditionally, employees have lost any FSA money not spent by the end of the year. However, a new provision outlined in the video below presents a partial fix for this problem.
Save Money on Taxes by Doing Other Things the Government Likes
There are several other behaviors the U.S. government encourages. These include giving to charity, buying a home, starting a business, filing jointly if married, learning and increasing energy efficiency. Each come with tax breaks. Most require itemizing deductions as opposed to taking the standard deduction.
Giving to charity. As long as donations of cash or property are made to qualifying organizations, they subtract from taxable income.
Buying a home. The government likes to see its citizens invest in homes. Therefore, mortgage interest on home loans is tax deductible. An extra payment before the end of the year can increase the tax savings even more.
Starting or Running a Business. The home office deduction reduces tax liability. Those with home offices subtract 100% of expenses directly related to their business, and a portion of many other home expenses, like electricity and heat.
Filing Jointly. Married couples who file jointly receive more tax deductions and credits than those who file separately. For example, filing separately prevents taxpayers from claiming the Earned Income Credit and education credits. It also forces both spouses to use the standard deduction instead of itemized deductions.
Education. An employee paid partly in education can get a tax break. The IRS allows up to $5,250 of tax free education pay per year. For example, if Bob makes $40,000 per year, but he takes $5,000 of that from his employer in the form of payments for higher education classes, he only has to pay taxes that year on $35,000 of his income. A substantial tax savings.
Energy Efficiency. Home improvements like adding energy efficient windows and insulation are tax deductible. Energy efficient heating and cooling systems, solar power and electric cars will also shrink a tax bill.
Save Money on Taxes (or Receive Money) Because of Need
The IRS has several built in methods of helping those who need it. For instance, the tax brackets are arranged so those who earn less pay a lower tax rate. Personal exemptions ($4,000 in 2015) and the standard deduction ($6,250) mean the first $10,250 of everybody’s income is tax free. Beyond these protections, there’s the Earned Income Credit.
The Earned Income Credit is a tax break for low income working people. “Low income” depends on factors like being married or having children. An individual with an adjusted gross income less than $14,590 in 2014 will qualify for the credit. Such an individual may receive not only a tax break, but also a check for up to $496. Couples who are married filing jointly with three qualifying children and less than $52,427 in income can also claim the credit. They may receive a check for up to $6,143.
The credit doesn’t go to people who don’t work at all. To receive the credit, taxpayers must earn at least some income. However, if they qualify, they can receive money even if they didn’t pay in any to begin with.
The IRS EIC Assistant can help taxpayers learn whether they can claim the credit. This handy Earned Income Credit Estimator, from the National Earned Income Credit Outreach Campaign, makes figuring eligibility for the credit even simpler.
The Bottom Line
Taxes are inevitable. Paying a lot of money on taxes isn’t. Using tax software or hiring a professional are both ways to get the biggest refund possible. Changing certain habits, like saving more or engaging in other behaviors encouraged by the government, can also save taxpayers money at tax time. And finally, some tax breaks are there to help people just because they need it.
Check out this new Earned Income Credit video from the IRS below:
- COLA Increases for Dollar Limitations on Benefits and Contributions – IRS.gov
- Health Savings Accounts (HSAs) – U.S. Department of the Treasury
- Eight Tips for Deducting Charitable Contributions – IRS.gov
- Employer-Provided Educational Assistance – IRS.gov
- EITC, Earned Income Tax Credit, Questions and Answers – IRS.gov