There are many tax deductions you can take to lower your overall tax bill in the United States. The U.S. tax code is perhaps the most complex piece of legislation that exists to date, generally providing tax breaks for the rich.
But even so, the average person who understands what is and isn’t allowed in the tax code can yield many financial benefits. Doing so will allow you to getting money back from the government, a skill highly coveted by wealthy businesses and individuals.
Here are ten taxes you could be overpaying for and how you can reduce your tax bill when you need to file for taxes
1. Personal Income Tax
This tax consists of federal (U.S.) and state income taxes.
How to Reduce It:
You can subtract the amount you invest into a tax-deferred retirement account (traditional 401(k) retirement plan, traditional IRA, or SEP-IRA) from your taxable income. Unfortunately, you don’t eliminate the taxes, just defer it for a later date. You’ll have to pay up when you eventually take qualified distributions (withdrawals) later on.
2. Capital Gains Tax
When you sell assets at a profit (such as buying and selling stocks), it triggers a capital gains tax. If you’ve held them for less than one year, you face a short-term capital gains tax, which is equivalent to regular income tax.
How to Reduce It
You pay no taxes if you earn these profits in a tax-free retirement account. Alternatively, you can hold onto stock shares for more than one year to pay the long-term capital gains tax upon sale.
The tax rate for long-term capital gains is:
- 0% for income below $78,750
- 15% for income between $78,750 and $434,550
- 20% for income over $434,550
3. Federal Income Tax
The federal income tax follows a progressive tax rate, where higher income brackets have higher tax rates. The government splits your income into these corresponding brackets. You only pay the higher tax rate on the portion of income that falls within the higher tax brackets.
How to Reduce It:
Specific deductions can reduce your bill when you file during tax season. Determine whether a standard deduction ($12,400 for single filers, $24,800 for married filers) can reduce your tax bill more than your itemized deduction. The standard deduction is a no-questions-asked reduction in your taxable income.
If you opt for an itemized deduction, you can deduct the following expenses:
- the portion of medical expenses exceeding 10% of adjusted gross income
- dependents
- state and local taxes (more on this later)
- student loan interest
- mortgage interest up to $750,000 of mortgage debt if house purchased on or after 12/16/17 ($1,000,000 if before)
- state rebate programs
- charitable contributions
- business travel
- education expenses
- theft or loss of property
4. State and Local Income Tax
State and local governments take out a portion of your paycheck. States without income tax include Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.
How to Reduce It:
Move to a state without income taxes listed above. You can also deduct a maximum of $10,000 from State and Local Tax (SALT) Deductions on your annual federal tax return. SALT Deductions include:
- non-business real estate property tax
- personal property tax
- either state/local income taxes OR state/local sales tax (but not both)
5. Sales Tax
Sales taxes apply to goods and services that businesses provide.
How to Reduce It:
If you use these items in the course of your business, you can deduct the costs as business expenses. Goods and services include supplies, furniture, equipment, software, and insurance premiums.
For example, you’ll be able to deduct expenses for equipment, repairs, instructional books, and website-related costs as a photography business. But the IRS requires proof that your business is for-profit and not just a tax shelter.
6. Property Tax
A portion of your property’s value is paid in taxes each year. Real estate prices and the property tax rate vary by state.
How to Reduce It:
Move to a state with low property tax rates and real estate prices. You can also opt to use part of your home exclusively for business purposes to get a tax deduction on that portion. Otherwise, itemize your tax return and add it to your SALT deductions.
7. Social Security Tax
The U.S government collects taxes to fund your social security income, which you receive during retirement. But some state governments want their cut as well, so they tax you when you get the payments!
How to Reduce It
Fortunately, you can avoid this double tax by moving to Alabama, Hawaii, Illinois, Kansas, Louisiana, Massachusetts, Michigan, Mississippi, New York, or Pennsylvania. You still pay taxes to fund social security in these states, but none when you receive it.
8. Gift Tax
When your gift value exceeds a certain amount, the government requires that you report and pay taxes on it. Even if you sell an item priced below its full value, the difference is considered a gift.
How to Avoid It: You can gift $15,000 to each recipient annually without facing tax consequences. Additionally, you can avoid taxes on the gifted portion over $15,000 by subtracting it from your lifetime gift tax exemption ($11.4 million).
9. Inheritance Tax
Once you pass on your assets to your heirs, they may be facing a tax headache.
How to Avoid It
You and your spouse can each give $11.4 million in lifetime gifts without being taxed. This tax exemption and the annual gift limit of $15,000 are mutually exclusive. You can also pass on assets in a tax-free retirement account (Roth 401(k) or Roth IRA) and to your beneficiaries upon death.
10. Retirement Income Tax
You pay taxes on distributions you receive from a tax-deferred retirement account. These distributions are considered taxable income.
How to Avoid It:
To get tax-free distributions during retirement, invest in a tax-free retirement account (Roth 401(k), Roth IRA) instead. You’ll still have to pay taxes before you contribute money to this type of retirement account, but you’ll owe nothing on the earnings (which can increase your tax bill in the future).
But if you want the best of both worlds, consider investing in a Health Savings Account (HSA) to avoid the tax altogether. You’ll only be able to use it for medical expenses and can only contribute to one if you have a high-deductible health plan.
Conclusion
With such an extensive tax code and annual changes, it would be nearly impossible to figure out all the ways to save money on your taxes. While this is not an exhaustive guide, it serves as a good foundation for anyone who wants to figure out if they’re overpaying in taxes.
Want more tips? Learn how you can invest your time and money more efficiently.
If you think I missed an important detail or method to save on taxes, let me know in the comments!