5 Proactive Tax Planning Steps to Legally Reduce your Tax Liability
Saving tax payments by reducing your tax liability legally can help you improve your financial position. Learn how you can save on tax payments through this quick guide.
Tax payments can take a toll on your finances because you’ll pay a good percentage of your total income for taxes. While it’s a legal obligation to pay taxes, there are some ways to reduce your tax liability to some extent legally.
With the right tips, and guidance from a tax planning advisor, you can save plenty of tax payments and use them for your savings or further investments. Remember, the ways we will mention proactive tax planning steps for reducing tax liability are entirely legal. You can easily incorporate them into your financial approach and save tax payments.
How Do Federal Taxes Work?
Individuals and businesses must pay federal, state, and local tax payments. These tax payments are applicable on the earned income and the additional levies needed to add funds to the Social Security programs.
These taxes also help other social welfare programs, such as Medicare, providing people with better benefits.
Avoiding these taxes on your income may seem like a lot of work, but there are some strategies to reduce your tax liabilities. Here’s our selection of the top steps to legally reduce the liability on tax payments.
1. Make Municipal Bond Investments
Anyone who makes municipal bond investments primarily gives a loan to the state or their local state government in exchange for an interest payment over a fixed period. Once the bond investment reaches maturity, the investors get their total invested amount back.
All the interest gained from these bonds is free from federal taxes and may have other tax exemptions in some cases. It is one of the safer investment options but requires keeping your investment on hold for extended periods.
Nonetheless, these municipal bond investments may offer a lower interest rate, but it’s still great, considering there’s little risk involved. Moreover, municipal bonds’ tax-equivalent production makes them ideal for long-term investments and can increase based on your tax bracket according to most.
2. Shoot for Long-Term Capital Gains
Investment is a great way to increase one’s wealth over time, and long-term capital gains are the way. There’s a variety of long-term investment options that you can consider investing in to reduce your tax liability:
- Real estate.
- Mutual funds
- Bonds, etc.
Investors with capital gains from an investment done more than a year ago may also get a preferential tax ranging between 0% and 20% based on the investor’s income.
Holding the assets for less than a year gets taxed according to the usual interest rates.
The tax bracket for the year 2022 is $83,350 for married couples, but singles have to pay a tax of $41,675. A tax planning advisor can help you sort these details out and find the most viable option to reduce tax payments.
Similarly, harvesting your taxes can offset a capital gains tax liability if you sell it at a loss. If your capital losses are more than the capital gains, amounts less than $3,000 are deducted from your income. The capital losses of more than $3,000 may move forward to upcoming tax years.
3. Start a Business
Starting a business venture may be one of the most effective ways to reduce your tax payment liability legally. Many business expenses can be counted in your final tax payments, reducing the total tax liability.
Moreover, Internal Revenue Service (IRS) guidelines allow business owners to deduct their home office costs from their taxation payments. Therefore, planning a business venture with even a small business accountantcan help reduce your overall tax payment requirement.
4. Max Out Retirement Accounts and Employee Benefits
In 2022, the income tax payments have minimized for contributions up to $20,500 according to the latest 401(k) or 403(b) plan, which was at $19,500 in 2021. The taxable slabs are much lower now, making it easier for more people to get taxed on a lower bracket. According to the latest changes, a person earning $19,500 to a 401(k) can reduce their taxable income to as low as $80,500.
People without a retirement plan can reduce their tax payments by making changes to payments up to $6,000 or $7,000 for individuals at 50 years of age or higher. Taxpayers with workplace retirement or a spouse with similar benefits can deduct some or all of the conventional IRA contribution based on their income.
The IRA deductions differ for each income level higher in 2022 than 2021. It mainly depends on the following:
- ● Married couples filing taxes separately
- Joint return
- Considerations for taxpayers with another account
- A single taxpayer’s return
The IRS provides detailed guidance about these deductions to make it easier.
If you look at the time before the SECURE Act, account holders with 401(k) or IRA needed to withdraw the minimum distributions (RMDs) before reaching the age of 70½.
The SECURE Act turned that age limit to 72, which has tax implications based on the age at which the account holders make a withdrawal. With the bill, there’s no maximum age for the standard IRA contributions that the individuals pay at the age of 70 and a half years.
Apart from the retirement plan contributions, some employers may also have fringe benefits that let these individuals separate the contributions made. It also includes the income benefits received by these individuals. The benefits received from the employer appeared as non-taxed amounts on within the employee statements.
These benefits include:
- Transportation cost reimbursements
- Group-term life insurance
- Flexible spending accounts
- Educational assistance programs
- Adoption expense reimbursements
- Deferred compensation arrangements.
5. Use a Health Savings Account (HSA)
If you are paying a high amount on your health insurance deductions while employed, you can opt for the health savings account (HSA) for tax reduction.
The 401(k) and the HSA contributions do not count toward the employee’s taxable income. Therefore, the contributions made to an HSA account can be 100% deducted directly from their incomes.
- For the year 2021, the maximum HAS payment deductible was $3,600 and $7,200 if you are a family member.
- In 2022, the maximum amount increased to $3,650 for individuals, whereas families have to pay $7,300
The funds you gather from these tax deductions can grow without further tax-earning payments.
Saving money on tax payments can help you get extra cash and use it for more beneficial purposes. Al the tax-saving methods mentioned in this piece are 100% legal. However, consulting with a professional for personal tax preparation or small business formation can help you save more in the long run.