7 Strategies to Reduce Your Tax Liability & Keep More Money in the Bank

how to reduce tax liabilities

Are you tired of watching a big chunk of your hard-earned money vanish into thin air through taxes? Well, here’s a secret to help you keep more of that cash: learning how to minimize your tax liabilities.

Tax laws are complicated, and navigating them can be challenging, but with some effort and knowledge, you can significantly reduce your tax bill (without stashing money in the mattress).

If you really want to take control of your finances and keep more of what you earn, you need to know these seven tax reduction strategies to lower your taxable income and help reduce the amount of tax you owe.

1. Understand the Tax Code

By understanding the federal tax code, you’ll be able to find deductions and credits that can significantly lower your tax bill. Tax code comprehension is crucial in identifying legal tax loopholes that can reduce your taxable income. Knowing which expenses are tax deductible and which credits you qualify for can significantly affect how much money you owe to the government.

To understand the tax code, stay updated on any changes or updates made by the IRS. The tax code is a complex set of rules and regulations that require careful study and interpretation. By familiarizing yourself with various law provisions, you’ll be better equipped to identify opportunities for legally reducing your taxes.

Take advantage of resources such as online guides, instructional videos, and IRS publications to help you navigate through this maze of rules.

2. Take Advantage of Tax Deductions

Maximize your potential tax savings by discovering all the possible deductions you can claim. One way to do this is by itemizing expenses instead of taking the standard tax deduction. This allows you to deduct specific expenses, such as charitable contributions or business expenses, from your taxable income.

When itemizing expenses, remember that only certain expenses qualify for deductions. These include medical and dental expenses, state and local taxes, mortgage interest payments, and certain types of charitable donations. Keep accurate records and receipts for all deductible expenses throughout the tax year.

3. Use Tax Credits on Income Tax

To get the most out of your tax return, don’t forget to take advantage of tax credits. Maximizing credits can greatly reduce your tax liability and increase your refund. Tax credits are different from deductions because they directly reduce the amount of taxes owed instead of simply reducing taxable income.

It’s important to note that not everyone is eligible for every tax credit. Eligibility criteria vary depending on the specific credit. Some common tax credits include the Earned Income Tax Credit (EITC), Child Tax Credit, and American Opportunity Tax Credit (AOTC). Before claiming any tax credit, ensure you meet all eligibility requirements and have all necessary documentation to support your claim.

4. Contribute to Retirement Accounts to Reduce Taxable Income

To reduce your tax liabilities, contributing to retirement accounts is a smart move. You can choose from different types of retirement accounts, including Traditional and Roth IRAs, 401(k), and other employer-sponsored plans. All of these options offer tax benefits that could help minimize the amount you owe in taxes each year.

Traditional and Roth IRAs

While it may seem tempting to rely solely on a Traditional IRA for retirement savings, it’s important to consider the potential benefits of a Roth IRA, even if you anticipate being in a lower tax bracket during retirement.

Here are some reasons why a Roth IRA may be the best option for tax savings:

  • Tax-free withdrawals: Unlike Traditional IRAs, where withdrawals are taxed at your current federal income tax rate, qualified withdrawals from a Roth IRA are completely tax-free.
  • No required minimum distributions (RMDs): With Traditional IRAs, you must start taking RMDs once you reach age 72, which can increase your taxable income and potentially push you into a higher tax bracket. With Roth IRAs, there are no RMDs.
  • Tax diversification: Having both Traditional and Roth IRAs can provide tax diversification in retirement, which can help manage your overall tax liability.

Considering these factors, it’s worth exploring the benefits of opening or converting to a Roth IRA as part of your retirement planning strategy.

401(k) and Other Employer-Sponsored Plans

If you’re lucky enough to have access to a 401(k) or other employer-sponsored plan, congratulations – this is an opportunity to set yourself up for financial security in the future.

The first step towards reducing your tax liabilities through these plans is maximizing your contributions. This means contributing as much as possible to the plan each year, up to the maximum amount allowed by law. Currently, the maximum annual contribution limit for 401(k) plans is $19,500 for individuals under age 50 and $26,000 for those over age 50.

Another way to reduce your tax liabilities with an employer-sponsored plan is by taking advantage of employer matching. Many employers offer matching contributions up to a certain percentage of their employee’s salary.

For example, if your employer offers a 100% match on the first 3% of your salary that you contribute, and you earn $50,000 per year and contribute 3%, then your employer would add another $1,500 into your account each year. This not only increases the total amount saved but can also significantly lower taxable income by reducing taxable earnings while increasing retirement savings at the same time.

5. Consider Tax-Loss Harvesting

When considering tax-loss harvesting, you’ll want to offset capital gains tax with losses. This means that if you have investment gains for the year, you can sell investments that have decreased in value to offset those gains and reduce your tax liability.

However, it’s important to be mindful of wash sale rules. These rules prevent investors from selling a security at a loss and buying the same or similar security within 30 days before or after the sale.

Offset Capital Gains with Losses

Maximize your tax savings by offsetting capital gains with any losses you may have incurred. This great tax loss strategy can help you reduce your overall tax liabilities. Using this approach, you can keep more of your hard-earned money and reinvest it in other areas of your life.

To make the most out of this opportunity, consider investment diversification. This means spreading your investments across different sectors, asset classes, and regions to minimize risks and maximize returns.

Here are three reasons why diversification is important for offsetting capital gains:

  1. It helps you avoid putting all your eggs in one basket.
  2. It reduces the impact of market volatility on your portfolio.
  3. It gives you access to a wider range of investment opportunities to generate returns while minimizing risks.

Overall, offsetting capital gains with losses effectively reduces taxes and increases wealth over time. Don’t miss out on this opportunity to optimize your financial future!

Be Mindful of Wash Sale Rules

Be careful not to trigger wash sale rules when selling securities at a loss, as this can result in the disallowance of your capital losses for tax purposes. The wash sale rule is designed to prevent taxpayers from generating artificial losses by selling securities at a loss and immediately repurchasing them.

If you sell a security for a loss and buy it back within 30 days before or after the sale, you will trigger the wash sale rule. Tax loss selling is an investment strategy that involves selling securities at a loss to offset capital gains and reduce tax liabilities. However, if you’re not mindful of the wash sale rules, you may inadvertently disallow your capital losses and end up with a higher tax bill than anticipated.

6. Plan Ahead

To minimize your tax liabilities, planning ahead and taking advantage of tax-saving options is essential. Long-term planning and financial forecasting can help you identify opportunities to reduce your tax burden.

Here are three ways you can plan ahead to lower your taxes:

  1. Contribute the maximum amount to your 401(k): By contributing the maximum amount allowed by law ($19,500 in 2020), you reduce your taxable income for the year. This means you’ll owe less money in taxes come April.
  2. Take advantage of deductions: Deductions are expenses that reduce your taxable income. Some common deductions include charitable donations, mortgage interest, and medical expenses.
  3. Consider a Health Savings Account (HSA): An HSA allows you to contribute pre-tax dollars towards healthcare expenses. Not only does this reduce your taxable income, but it also helps you save money on healthcare costs throughout the year.

Planning and taking advantage of these options (and others) can significantly reduce your tax liabilities and keep more money in your pocket.

7. Create a Tax Plan With Professional Guidance

If you feel overwhelmed by your tax obligations, talking to a tax advisor can help. They can navigate the complexities of the system and find ways to reduce your liabilities. A good tax advisor can minimize your tax burden, ensure compliance with regulations, and optimize your financial situation.

Consider these things when hiring a tax advisor:

  1. Look for a qualified professional with relevant education and experience in taxation.
  2. Consider whether the advisor has expertise in specific areas relevant to your situation (e.g., small business taxes, international taxes).
  3. Choose someone willing to listen to your needs and communicate clearly and effectively throughout the process.

At The Titus Law Firm, we have experienced tax lawyers and staff with previous experience in tax advising and preparing. Our team can advise you on maximizing your tax benefits while minimizing liability.

With our experience in tax laws, regulations, and codes, we can help you identify deductions and credits that could lower your taxable income while also helping you work with IRS if any legal issues arise. Contact us today to learn more.

Author Bio

Eddison S. Titus

Eddison S. Titus is the Founder of The Titus Law Firm, a Houston estate planning, business law, and real estate law firm he founded in 2016. He has successfully represented clients in a wide range of legal matters, including will and trust creation, probate, real estate transactions, business formation, business and contract disputes, and business succession planning.

Eddison received his Juris Doctor from the Charlotte School of Law and is a member of the State Bar of Texas.

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