Maximize deductions
Tax deductions reduce your taxable income. Generally, you can take a standard deduction or itemized deductions. Itemized deductions include costs for medical and dental care, property taxes, state income taxes, mortgage points and mortgage taxes, business expenses and charitable contributions.
Maximize tax credits
Tax credits are used to lower your taxes dollar for dollar. IRS tax credits include:
- Earned income tax credit (EITC)
- First-time homebuyer credit
- Education credit
- Child and dependent care credit
- Adoption credit
- Retirement savings contributions credit
The credits available change every tax year, so make sure to check that the credits you are relying on will be available for the given tax year.
Contributing to a retirement account – 401k or IRA
By contributing to a 401k retirement account (employer-sponsored) or individual retirement account (IRA), you can reduce your taxable income and lower the taxes you owe. Pre-tax money is deposited into the 401k account and growth is tax deferred. An individual retirement account offers similar benefits.
Following the Setting Every Community Up for Retirement Enhancement Act (SECURE) of 2019, seniors can now contribute to IRA accounts indefinitely. This new law also raised the age that seniors must take required minimum distributions (RMD) from their 401(k) and IRA accounts. In the past, RMDs had to be taken at age 70 ½ – the age has now increased to 72 years.
Opening a health savings account
Contributing to a health savings account, if you have an eligible high-deductible medical plan, is another way to lower taxable income. Contributing to these accounts provides an immediate tax deduction, they grow tax-deferred, and withdrawals for qualified medical expenses are tax-free. Any balance left at the end of the year is rolled over indefinitely.
Contributing to employer-sponsored plans
Contributing to a traditional 401(k) or 403(b) plan through your paychecks offers a dollar-for-dollar reduction in your taxable income. The Roth 401(k) or Roth 403(b) don’t provide upfront tax benefits; however they do allow for tax-free withdrawals later on.
If an employer-sponsored plan isn’t available to you, you should consider a traditional IRA instead. Any contributions to these will be made with pre-tax dollars. This means that you will have less taxable income and lower tax liability.
