Tax Strategies and Concept Illustration

7 Tax Strategies & Concepts: The Art of Reducing Tax Liability

The Key Points

  1. Strategic tax planning can identify opportunities for reducing tax liabilities.
  2. Learn about common tax incentives implemented by governments to encourage specific behaviors or investments by providing individuals or businesses with favorable tax treatment.
  3. By keeping organized records and staying informed about changes in personal circumstances, individuals can navigate tax seasons more efficiently, reduce the risk of audits, and optimize their financial outcomes.

Table of Contents

  1. Know Your Tax Bracket
  2. Understand the Difference Between Credits and Deductions
  3. Decide Between Standard and Itemized Deductions
  4. Leverage Tax Credits and Deductions
  5. Prioritize Recordkeeping
  6. Adjust Your W-4 Withholding
  7. Utilize Tax-Advantaged Accounts
  8. Conclusion

Filing your taxes can seem overwhelming, especially with dozens of decisions. However, taking the time to analyze your tax situation and find useful tax incentives is important to reduce your tax bill when it comes time to file. Here are 7 common tax strategies and concepts you should know before tackling your tax filings.

1. Know Your Tax Bracket

Your tax bracket determines your tax rates. It is based on your filing status. The main filing statuses are single, married filing joint, married filing separately, and head of household. The qualifying widower is less common and should only be used after consulting with an expert.

Your tax bracket rate can range from 10% to 37%, depending on your income and which filing status you choose. Regardless of your tax bracket, you most likely won’t pay that tax rate on your entire income. For one, the IRS allows taxpayers to claim a standard or itemized deduction. Second, if you are a business owner or entrepreneur or have a side hustle, you may qualify for Qualified Business Income Deduction.

In addition, tax brackets are based on a marginal system. This means that the first portion of your income will be taxed at 10%, the next chunk at 12%, and so on. Knowing your tax bracket can help you plan your upcoming liability and factor in the credits and deductions you are eligible for. Below are tables that outline the threshold that each tax rate starts at.

Marginal tax brackets for tax year 2023

Tax RateSingleMarried Filing JointlyMarried Filing SeparatelyHead of Household
10%$11,000$22,000$11,000$15,700
12%$44,725$89,450$44,725$59,850
22%$95,375$190,750$95,375$95,350
24%$182,100$364,200$182,100$182,100
32%$231,250$462,500$231,250$231,250
35%$578,125$693,750$346,875$578,100
37%$578,126$693,751$346,876$578,101

Marginal tax brackets for tax year 2024

Tax RateSingleMarried Filing JointlyMarried Filing SeparatelyHead of Household
10%$11,600$23,200$11,600$16,550
12%$47,150$94,300$47,150$63,100
22%$100,525$201,050$100,525$100,500
24%$191,950$383,900$191,950$191,950
32%$243,725$487,450$243,725$243,700
35%$609,350$731,200$365,600$609,350
37%$609,351$731,201$365,601$609,350

2. Understand the Difference Between Deductions and Credits

Tax deductions reduce your taxable income, lowering the amount multiplied by your tax rate. On the contrary, credits carry a greater impact, as they are a dollar-for-dollar reduction of your tax liability. Certain credits may give you a refund even if you don’t owe any tax.


Case 1.

Facts:
  • Mary is a single Mom.
  • Her side hustle brings $160,000 in revenues in 2023.
  • The expenses are $50,000.
  • Mary has no other taxable income.
  • Mary is eligible for a child tax credit and can claim the Qualified Business Income Deduction (QBI).
  • Self-employment tax is ignored for simplicity
Issue:

How can Mary utilize deductions and credits to pay less tax?

Calculations:
  • Mary’s adjusted gross income is $110,000 [$160,000-$50,000]
  • Standard deduction is $20,800
  • QBI is $22,000 [$110,000 x 20%]
  • Taxable Income is $67,200 [$110,000 – $20,800 – $22,000]
  • Tax is $9,265 [$15,700 x 10% + $51,500 x 15%]
  • Child Tax credit is $2,000
  • Total tax without any consideration of self-employment tax is $7,265

Can you see the differences between credits and deductions? Maximizing your tax savings relies on leveraging all possible credits and deductions.

3. Decide Between Standard and Itemized Deductions

When it comes to “freebies,” the IRS has what’s called a standard deduction. This is a flat dollar amount you can deduct from your adjusted gross income.  

Tax YearSingleMarried Filing JointlyMarried Filing SeparatelyHead of Household
2023$13,850$27,700$13,850$20,800
2024$14,600$29,200$14,600$21,900

If your adjusted gross income is below these thresholds, you won’t have to pay any taxes.

However, the IRS allows taxpayers to increase their deduction from adjusted gross income by itemizing deductions. Certain medical expenses, home mortgage interest, state and local taxes up to $10,000, and charitable contributions are added together. If the total of these items exceeds your standard deduction, you can use itemized deductions to lower your income.

Itemizing deductions is common for homeowners, as property taxes and interest on mortgages can quickly add up. Nevertheless, you should only itemize your deductions if your total is greater than the standard deduction.

4. Leverage Tax Credits and Deductions

There are dozens of tax credits and deductions that you might qualify for. Here are some of the main ones and what they are for:

Credits:

  • Adoption Credit: Costs of adopting a child.
  • American Opportunity Credit: Higher education costs for the first four years.
  • Capital Loss Deduction: Losses on the sale of investments that offset your capital gains.
  • Charitable Contributions: Cash and property donations to charitable organizations.
  • Child and Dependent Care Credit: Costs associated with childcare, like daycare.
  • Child Tax Credit: Being a guardian with an eligible dependent.
  • Credit for Disabled and Elderly: Taxpayers with a permanent disability.
  • Earned Income Tax Credit: Taxpayers that have income below a certain threshold.
  • Electric Vehicle Tax Credit: Money back for purchasing qualifying hybrid and electric vehicles.
  • Residential Energy Credit: Money back for energy-efficient home upgrades.
  • Saver’s Credit: Contributions to an IRA with income below a certain threshold.
  • Lifetime Learning Credit: Qualifying education expenses.

Deductions:

  • Business Use of Home: Taxpayers that operate a business from their home.
  • Business Use of Car: Taxpayers that use their car for business.
  • Medical Expenses: Costs that insurance doesn’t pay, like prescriptions.
  • Mortgage Interest: Interest paid on your primary home loan.
  • Property Taxes: Taxes paid to your local village or county.

5. Prioritize Recordkeeping

With the IRS increasing their number of agents, more taxpayers are expecting to receive an audit. Although full-fledged audits are uncommon for the average taxpayer, you might receive a letter in the mail requesting more information. This is why it’s best to prioritize recordkeeping. At a minimum, you should keep all tax returns and supporting documentation for at least three years.

However, if you’ve been in disputes with the IRS before, these timeframes are extended:

  • If you underreported income by more than 25%, you should keep returns for six years.
  • Taxpayers who have written of a loss from worthless security should keep information for seven years.
  • Those who committed tax fraud in the past should hold onto information indefinitely.

What information should you keep? You should keep any and all information that supports the numbers reported on your return. This can include your W-2s, 1099s, bank statements for your business, childcare statements, home closing statements, and documents from a charity. The more information you can provide, the better.

The good news is that you don’t have to keep an old file folder with all of these documents tucked away in your office. Most taxpayers choose to scan these documents and keep electronic versions.

6. Adjust Your W-4 Withholding

When you accept a job, one of the first documents that human resources will make you fill out is a Form W-4. This form determines how much Federal tax is withheld from your paycheck. As your income increases or your life situation changes, it’s important to update your W-4. If you owe a significant amount of money when you file your taxes, an old W-4 might be to blame. The same is true for a huge refund.

For example, if you have a child or get married, you will qualify for more deductions and credits. If your W-4 still reflects your information as single, you may have too much tax withheld. Would you rather have more money back in your pocket throughout the year or a large refund when you file your taxes? That’s up to you.

If you don’t know where your withholding currently sits, ask your employer or accountant or take a proactive approach and fill out a new W-4.

7. Utilize Tax-Advantaged Accounts

  1. Pre-tax retirement accounts: Some accounts come with tax advantages beyond just a deduction on your return. Pre-tax retirement accounts, like the 401(k) your employer offers, are deducted from your gross income. This means you are making contributions with dollars that have not been taxed. The downside of this option is that you will have to pay taxes when you pull the money out in retirement. Nevertheless, this can be an alternative to other ways to lower your taxable income and plan for retirement.
  2. Flex spending account: Tax-advantage account that allows you to contribute pre-tax dollars to use on daily medical expenses, like Band-Aids and Advil. Similarly, a health savings account also comes with pre-tax contributions. Funds within this account can be used for larger medical expenses, like doctors’ visits and prescription medicine.
  3. 529 college savings accounts: There are education accounts designed to help you save for your child’s future and lower your taxable income. 529 account contributions are made with dollars that have already been taxed, but the growth inside the account is tax-free as long as the money is used for educational purposes. In addition, many states give taxpayers credit for contributions to these accounts. If your child is planning to attend college, keep a 529 account in mind.

8. Conclusion

By incorporating these strategies into your tax planning, you can enhance your financial well-being and make informed decisions to optimize your tax outcomes. Always stay informed about the latest tax regulations and seek professional advice for personalized guidance.


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