How to Reduce Income Taxes
Paying taxes is said to be as inevitable as death, so while you can't get out of paying taxes, are there things you can do to reduce your income taxes? Try the following:
- Participate in company retirement plans. While each retirement plan is slightly different, in general every dollar you contribute will reduce your taxable income and thus your income taxes. Of course, you will pay taxes on that money at some point, but there are ways to make it as little as possible. So, contribute the maximum amount to your retirement plan each year.
- Enroll in your company's flexible spending account. You can set aside money for medical expenses and day care expenses, and not be taxed on this money. This is a great plan if you know you will have these expenses, but because this money is "use it or lose it" type deal, you need to estimate the best you can.
- Make sure you pay in enough taxes to avoid penalties. If you want to reduce your income taxes, do not underpay as Uncle Sam charges interest and penalties if you don't pay in at least 90% of your current year taxes or 100% of last year's tax liability. This can get costly.
- Buy a house. When you own your home, the mortgage interest and real estate taxes are deductible from your taxes, thus reducing your liability.
- Keep your house for at least two years. This way when you sell your home, you can exclude up to $250,000 ($500,000 for joint filers) of profit on the sale of your home from your income. To qualify for this you have to have lived in the home for at least 2 years of the last 5.
- Time your investment sales. If your income is higher than expected and you income tax may be high, sell some of your loser investments to reduce taxable income. If you will be selling a mutual fund, sell before the year-end distributions to avoid taxes on the upcoming dividend or capital gain. Or, consider allocating tax efficient investments to your taxable accounts and non-efficient investments to your retirement accounts, to reduce the tax you pay on interest, dividends and capital gains.
- If you're retired, plan your retirement plan distributions carefully. Do what you can to keep yourself in a lower tax bracket in order to keep more of your retirement savings for you.
These are just a few examples of ways you can reduce your income tax. To be most effective at reducing the amount of income tax you pay, it is wise to take the time to become aware of the tax deductions and credits that apply to you and to plan for taxable events.