Ask a MoneyGeek: How Do I Cut My Tax Bill?
Q: Federal income taxes are taking so much of my paycheck! How do I reduce my taxes at the end of the year?
The easiest way to reduce Uncle Sam's cut of your pay is to reduce what you earn. I know: not the ideal move. But you can reduce your taxable income a couple of ways, cut your tax bill and still come out on top.
Save for retirement
First, think ahead, like retirement years ahead. If your company offers a workplace 401(k) plan, enroll and contribute as much as you can. Currently, you can contribute up to $19,500 (the amount is adjusted annually for inflation) to a 401(k) account. And that's pre-tax dollars, meaning your contributions are made before your payroll department figures how much income tax to withhold from your check. If you're age 50 or older, you can make catch-up contributions of another $6,500.
So, your 401(k) contributions build your nest egg over time while reducing your current tax bill.
Yes, $19,500 (or $26,000 if you're older) is a lot of money. But you don't have to contribute the maximum allowed. Just put in what you and your budget can afford. Try to contribute at least as much as your company will match so you don't waste that "free" retirement money. But the key is to contribute something. Every bit counts.
Don't miss deductions
Make sure you maximize your possible tax deductions.
You also can itemize donations to charity. This includes not only cash contributions to your favorite nonprofit, but also goods donated, such as household items and clothing. The fair market value of those items count as charitable deductions.
Of course, you'll only itemize if all your allowable Schedule A expenses are more than your standard deduction amount. Most people claim the standard amount, not only because they don't have enough to itemize, but also because it's easier.
But you still can claim what are known as above-the-line deductions regardless of which deduction method you use. These officially named "income adjustments" help trim your total, or gross, income amount to a lower adjusted gross income amount. Again, the less money that's within the Internal Revenue Service's reach, the lower your tax bill.
There are more than a dozen above-the-line deductions on the long Form 1040; four also show up on the shorter 1040A. Here are some that are relatively easy to claim:
- Contribute to a traditional IRA. Depending on your income and whether you have a workplace retirement plan, you can write off some of or all your contributions to this retirement plan.
- Tally your moving expenses if you relocated for work purposes. While this isn't available if you're moving for your very first job, subsequent work-related moves do count. These costs include the transport of your personal goods, some storage costs, your lodging while moving, the miles you drive your own vehicle to your new home and even the cost to move your pet.
- Open a retirement account for side-hustle money. If you had gigs, either as your main income or to supplement your salary, you must report that income and pay taxes on it. But you also can open a separate retirement account, such as a SEP-IRA or solo 401(k), for that extra money. And you can deduct that contribution amount as an adjustment to your overall income.
Get all your possible tax credits
Finally, don't overlook credits. These are better than deductions because they provide dollar-for-dollar reduction of your final tax bill. They can reduce what you owe the U.S. Treasury to zero and, in some cases, even get you a refund.
If you took some courses to help you do your job better, look into claiming the Lifetime Learning Credit. This could shave up to $2,000 off your tax bill.
Remember all those retirement accounts in which you stashed money? They could help you knock $1,000 off your tax bill if you qualify for the Saver's Credit.
And don't forget about the Earned Income Tax Credit, or EITC. A lot of folks ignore this tax credit because they don't realize they qualify; they think it's only for the very poor or taxpayers with children. While lower earners and those with children do get bigger EITC benefits, it's available to many middle-income workers, including those without kids. For the 2020 tax year, certain filers can make up to $56,844 and claim it. Even better, the EITC is one of the credits that could get you a refund.
Kay Bell, an award-winning journalist and creator of the Don't Mess With Taxes blog, has been writing about taxes for two decades. The native Texan's work has appeared online, in print magazines, TV and radio broadcasts and in her FT Press/Pearson book "The Truth About Paying Fewer Taxes."
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