The total income tax collected from different sectors of the U.S. population is distributed in different proportions between personal taxes and business taxes. There is a well-established federal income tax code. One of the most essential ways for reducing personal federal taxes is to have an effective strategy for annual tax planning. Below are ways you can reduce federal income tax.
You must make the most of your retirement plan options
If you are subject to U.S. taxes, it is always a good idea to look for ways to reduce your taxable income and tax liability. One of the best ways to do this is by contributing money towards your retirement plan.
The money you contribute to your retirement plan is not included in your W-2 and, therefore, can reduce your taxable income. In addition, after-tax contributions are also not taxed when you withdraw them at retirement age.
For example, if you make a $10,000 contribution to your retirement plan and after-tax contributions are 50% of your total contribution, then $5,000 will be excluded from your taxable income, and the other $5,000 will be taxed as usual at the time of withdrawal at retirement age.
It would be best if you always got as close as possible to maximizing your retirement plan contributions. If you are eligible for both a 403b and a 457b plan, you should contribute up to the maximum amount in each plan.
Make the most of the gift-tax exemption
The IRS allows you to give away $15,000 a year to any number of individuals before you have to report it. If you’re married, you and your spouse can each give away $15,000 per person for a total of $30,000 per individual.
You don’t need to file a gift tax return if you stay under this limit unless you are giving more than $15,000 (or $30,000 if married) directly to a political organization for its use in influencing elections.
How does gift-tax exemption work?
Any amount above the annual exclusion is applied against your lifetime exclusion amount. The annual exclusion applies per donee (person receiving the money). The annual exclusion does not apply when making gifts to your spouse or paying someone else’s medical or tuition bills. No part of your gift may be excluded from taxable gifts in those situations.
Contributions to 529 college savings plans should be maximized
A 529 plan is a tax-advantaged savings plan designed to encourage saving for future education costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.
How do 529 education savings contributions work?
Contributions to a 529 plan may be eligible for a state income tax deduction or credit in many states. Earnings grow federal tax-free, and distributions used for qualified college expenses are federally tax-free.
How can you utilize the 529 education savings contributions?
Contributions to a 529 plan may be eligible for a state income tax deduction or credit in many states. Earnings grow federal tax-free, and distributions used for qualified college expenses are federally tax-free.
Bundle contributions
Bundling is the process of combining multiple tax-deductible expenses into a single year. You would then shift those expenses that you can time forward or backward so that they occur in the year you want to maximize deductions.
How does a bundle contribution work?
Taxpayers who itemize their deductions can make charitable contributions, medical expenses, and other deductible payments at the end of the calendar year and deduct these expenditures on their tax return for that year, even if the bills are paid in January of the following year.
By prepaying expenses and deducting them before they are actually paid, taxpayers can receive a larger deduction than they would otherwise get by waiting until next year to pay the bills.
Liquidate investments that are losing money
A loss is a loss, but if you’re facing capital gains as well as losses, it only makes sense to liquidate investments that are losing money. This can help reduce your tax bill.
When you liquidate securities such as stocks or mutual funds, the profit or loss on those investments gets reported on your federal income tax return and may affect your income tax liability. If you have net short-term losses, you may be able to use them to reduce taxable income from other sources.
Short-term capital gains are taxed at ordinary rates, while long-term capital gains are taxed at lower rates. However, if your net short-term losses exceed your net long-term gains and any other income, up to $3,000 of the excess can be deducted against ordinary income such as wages, interest, and dividends.
As you can see, while there is a lot of information to cover, reducing your taxes isn’t that complicated. By taking advantage of all of the tax deductions and opportunities available to you, you can help ensure that you will never have to pay more tax than necessary. Just make sure that throughout the year, you save every receipt (and store them), track all of your expenses, and read tax news articles as they are published to stay up to date.
