A tax bill is one of the few things that can dampen your mood. While you can't entirely avoid paying any taxes, you'd likely prefer to pay as little on your taxes as possible. Luckily, you can use a number of legal strategies to reduce your tax payments.
1. Contribute to a Retirement Account
Virtually anybody can use retirement account contributions to lower taxable income. The most common retirement account contribution is a 401(K). The amount that goes into the 401(K) comes from your pretax income.
2. Tweak Your W-4
The W-4 is a document that you provide to the employer and indicates the amount of tax to be withheld from your salary. Increase your withholding amount if you have a high tax bill in the current year. High withholding amount ensures that you will pay less when you make your tax filings. On the other hand, reduce the withholding amount if you qualify for a big refund from the IRA.
3. Check If You Qualify for the Earned Income Tax Credit (EITC)
The qualification requirements for EITC may be complicated. But, if your income is low, you should probably check if you qualify for the tax credit. The qualification requirements include marital status, income, and the number of children. If you qualify, you may receive tax credits of almost $7,000.
Tax credits are dollar-for-dollar decreases in tax payments. Consequently, a tax credit can reduce your tax amount to zero, and the IRS will have to refund all of your money.
4. Contribute to a Health Savings Account (HSA)
A health savings account is vital for people with high-deductible medical plans. The savings account allows you to put aside some funds to cater to specific medical costs.
HSA contributions have massive benefits since they reduce your taxable income. Also, all the investment income in an HSA is pre-tax. Similarly, you don't pay any taxes on HSA withdrawals, provided that the funds in the account cater to approved medical costs.
The maximum pre-tax HSA contributions in 2022 are $3,650 for individual medical cover and $7,300 for family medical cover. You can either use your own high-deductible health care plan or a Flexible Spending Account (FSA) offered by your employer.
5. Register for an Employee Stock Purchasing Program (ESPP)
Employee Stock Purchase Plan is available for people working for publicly traded corporations. The ESPP allows you to use your after-tax money from your salary to buy shares in your company. Typically, you should receive a discount of about 15% of the stock price.
You will decide the amount you want to put in your ESPP, but most employees use about 1% to 10% of their after-tax dollars. Also, you can't spend more than $25,000 per year on an ESPP account.
An ESPP's tax benefits become apparent during the sale of the shares. The longer you hold onto the shares, the less income tax you will pay on the returns. Moreover, selling the shares after a long time comes with reduced capital gains tax.
6. Invest in Municipal Bonds
When you buy municipal bonds, you are essentially providing a loan to the local or state government. The government entity will then repay the loan within a specific period. When the bond matures, you will also receive the entire amount of your original investment.
One benefit of municipal bonds is that they are not subject to local or state taxation. However, the rate of return on municipal bonds is relatively lower than on other bonds.
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