5 Ways to Minimize Your Taxes
Taxes, unfortunately, are a way of life. If you try to avoid paying them it won't end well for you. However we should all try our best to minimize what we have to pay to the good old government. After all, it's the biggest chunk of our salary we lose each pay!
There are several ways in which everyday folks like you and I can lower the overall amount we have to pay in taxes. If you're a business owner it's likely there will be more tax advantages available to you, but if you're not that's ok. The strategies we'll cover today are available to everyone.
Today we'll touch on 5 strategies for you to consider if lowering your tax bill is a goal for you.
1. Contribute to your tax-advantaged retirement account
Maxing out your IRA, 401(k) or Superannuation with pre-tax dollars is a great way to lower your taxable income. The amount you contribute is deducted from your taxable income and can sometimes result in you getting a credit in the form of a tax refund when you file your taxes.
The downside to this method is that you'll have a lower net income because you're contributing more of your gross income, but it's a powerful way to both lower your taxable income and supercharge your retirement investments. Contributions plus time equals massive compound growth, depending of course on the average return of your investments (hint: I like index funds. Read more here).
Each account type will have their maximum contribution limits so it's best you check how much you can contribute before going HAM on this method. Penalties may apply if you over-contribute to these accounts.
2. Give to a charity
Giving back is not only great way to help the underprivileged or community, it can also be good for your hip pocket. When you donate to a charity the value of what you donate can be used to offset your taxes. It doesn't just have to be a cash donation either.
Toys, clothes, books and other household items are all good examples of what you can pile up and give to the less fortunate. You can find apps or online calculators that can estimate the value of your goods before you donate so you know roughly how much you could claim.
Other related expenses such as travel to a charity event or volunteer work can also be deducted from your tax bill. Be sure not to try and claim your time though, as that isn't tax deductible.
3. Keep your savings in a mortgage offset account (if you own a house)
I know this one is specific to homeowners but it's a great one, and a lot of people own a home these days. If you're a saver, congrats to you! That's fantastic. But did you know that holding savings in a standard bank account - or even in a HYSA online - that the interest you earn on that money is added to your taxable income?!
It sucks, I get it. You're responsible enough to save and you get whacked with taxes on the money your money makes. A fantastic way to avoid this is by holding your savings in a mortgage offset account if your mortgage provider offers this service (most do these days).
The money you hold in this account will "offset" the interest you're paying on your mortgage. Put simply, if you have $20k in the offset account and your mortgage rate is 3.00%, you effectively reduce your mortgage by $20k at the interest rate of 3.00%. In other words, your money is saving you 3.00%.
Since mortgage interest rates are higher than any online savings account these days, your savings is put to better use in this account and you get the added benefit of not paying tax on it!
4. Keep receipts for EVERYTHING that could be a tax deduction
Instead of scrambling at the end of the financial year, trying to think of all the things you spent money on that could be tax deductible, collect your receipts throughout the year for anything you think could have even a remote chance of being tax deductible. This will make your life - and your accountants life - much easier come tax time.
It's highly likely not every receipt you keep can be used, but at least you'll have them all piled together and make an executive decision to throw some of them out if you deem them non tax deductible.
Common items can include home office equipment if you work from home, internet supply (full or part) if you use it for business purposes and eligible medical expenses. Check your local tax code for all deductions that may apply to you.
5. Make larger purchases near the end of the tax year (but only if you need them)
If you know you're income for the year is going to be in a higher tax bracket it might be worthwhile making a tax deductible purchase, provided that you actually need the item. Many people make the mistake of buying "stuff" that they don't even need at the end of the year for the sole purpose of claiming a deduction. In this case, they are spending a dollar to get a few cents in return.
If you truly need the item, the expense can be claimed against your taxable income and may even push you into a lower tax bracket. The reason for doing it at the end of the tax year is to lower your income for that year and you can claim it back relatively quickly if you file your taxes promptly.
Everyone who works should always do their best to lower the amount of taxes they have to pay. I'm a firm believer that paying taxes is needed for our modern society to function well, but you shouldn't pay more than you have to.
All the methods mentioned above are 100% legal and above board. No shady business here folks! The trouble is that they're not widely advertised so a lot of people don't know what they can and can't claim.
A reputable CPA that specializes in tax can be a great investment for you to bring on board for your finances. The good ones can really help your finances, so be sure to do your research and pick a good one if you want to go down that route.
I've only covered 5 tax reduction tips here today and there are plenty more, but tax isn't a very sexy subject to talk about so I capped it at 5 of the better ones for your reading pleasure.
Blake - FIRE with a family