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Wondering how to pay less taxes in 2021? Are you one of the millions who unknowingly pay more than they need to on taxes? The 7 tax strategies below could reduce your taxable income by up to $40,000, and save you up to $10,000 this year.
Tax season descends upon us once again and with it so does our collective stress and anxiety as a nation.
That’s right. The dreaded deadline is fasting approaching:
April 15th (dun dun dun).
It is a very sad time for a lot of us. But I’m here to make it a little better by teaching you how to save a TON of those dolla dolla billz on your taxes this year.
Thousands if not millions of people unknowingly pay more than they need to on taxes every year. Are you one of them? If so, understanding these very basic tax reduction strategies can help keep more money in your pocket at the end of the year.
And yes, I promise you this is all very legal.
A Quick History of Taxes
Taxes aren’t new. Some call taxes ‘the price of civilization’. Pharaohs in ancient Egypt used to tour the land confiscating cows or grain from their citizens. Taxes have been placed on everything imaginable from urine in Ancient Rome, to being a bachelor, and even having a soul – a tax from Peter the Great.
And it was a disagreement over taxes that led to the small tiff we now all know as the American Revolution. Yep. The Brits taxing colonists on tea turned into an all out war and our (once great) nation was born.
That’s right. The United States was actually founded on tax defiance.
So what could be more patriotic than a lesson on how you can save up to $10,000 on taxes this year?
You may protest that we need taxes to live in a functional society. And you would probably be right. But you should also know that taxation as it exists today is a new thing.
What You Need to Know About Taxes in the United States
The beauty of the United States is that it was income tax free in its infancy. The U.S. didn’t tax the general public but instead funded its initiatives through excise taxes on goods and services.
It wasn’t until the Civil War when Lincoln created the Internal Revenue Service and income tax began to do a slow creep into pockets of Americans.
The Beginning of Income Tax
The Revenue Act of 1861 incurred federal income tax until after the Civil War but was then found unconstitutional and revoked.
Income tax as we know it finally came to be in 1913 as an effort to finance World War One, and things have been going downhill ever since.
I recently went to visit my accountant in his office and admired a framed piece of parchment on his wall.
‘That is the original United States income tax form,” he offered.
I gawk for a minute longer at its brevity. It’s exactly one piece of paper.
Of course, that innocent little document has been an excuse for the U.S. Government to have an all out taxing free for all in the decades since.
Ever since that dark day in 1913, taxes have kinda snowballed out of control. In the last century we have added gift tax, sales tax, social security, cigarette and alcohol tax (also known as sin tax), capital gains tax, gas tax, and the list goes on.
These taxes are also often hidden in the price of things so you don’t really know you’re paying it. For example, the tax is imposed on companies which drives up the price of services or goods.
Now that that’s out of the way, let’s talk about how taxes work and how you can pay less on your taxes this year (legally!)
How to Pay Less On Your Taxes
Get ready because I am about to drop some serious alphabet soup on you. 401s, IRAs, 1040Bs – what does it all mean? And why do we have to use meaningless strings of numbers and letters to name all of our retirement accounts?
Here is your quick cheat sheet on how to pay less taxes. But first, a quick breakdown of the different type of taxes you should know about.
How to Pay Less Taxes As an Employee
1. The Standard Deduction
Everyone in US get an automatic deduction of $12,400 your taxable income (if you’re single) or $24,800 (if you’re married).
This is the easiest and most common deduction to apply.
2. How to pay less taxes with a 401K Contribution
The traditional 401K retirement plan is an employer-sponsored plan that allows you to invest PRE-TAX money. Anything you invest in your 401K (up to $19,000 a year) is deducted from your income.
For example, if you invest $100 per paycheck into a 401K you’ll be taxed as though you made $100 LESS on your paycheck.
For someone in a 24% tax bracket this could save you from paying about $4500 in taxes. If you’re self employed you can open up what’s called a Solo 401K – which allows you to contribute up to $56,000 per year.
You’re only taxed on this money when you begin withdrawing the money after the age of 59.5.
When you do decide to withdraw out of your 401K in your 60’s, if you have no income then your withdrawals will be taxed at a lower tax bracket.
3. Traditional IRA (Individual Retirement Account)
This is very similar to a 401K, except anyone can open one up at any time.
- You can contribute up to $6000 per year into this account that would then reduce from your total taxable income
- You can contribute pre-tax or after-tax dollars (but it makes more sense to contribute pretax)
- Your money grows tax deferred – meaning you don’t pay taxes until you take it out
- After the age of 59.5, withdrawals are taxed as income
- Ideally, you withdraw from this account when you have no income, so it is taxed at the lowest possible bracket of 10%
- You can open a rollover IRA to rollover your 401K into this account
4. How to pay less taxes with a Roth IRA
- You can contribute up to $6000 annually
- You can contribute after-tax dollars only
- Your money grows tax free
- You can make withdrawals that are tax and penalty free after the age of 60
- You can pull out what you put in without taxes or penalties (but any gains on investments need to stay put until you are 60)
Why have one?
You don’t have to pay tax on your investment gains. Let’s say you use your Roth IRA to buy $1000 worth of shares of Gamestop at $25 a share, and it goes up to $300 a share. When you take out that earnings, you don’t have to pay the 20% capital gains tax on it. They’re all tax free!
AND you can take out the thousand dollars you put in anytime. Cool, right?
To that end, someday I will teach about something called a ‘Roth Conversion Ladder’ which is one of the keys to early retirement. But this is an advanced strategy for another day.
5. How to pay less taxes with an HSA – Health Savings Account
Check if your employer offers an HSA. You can contribute up to $3500 per year in this account TAX FREE. The catch is, this account is specifically for any out of pocket medical expenses or charges that you incur. The good news is, any funds you don’t use will just roll over to the next year. And you can probably count on having medical expenses throughout your life, especially in old age. So it’s a good idea to max out this account.
There is also something called an FSA (Flexible Spending Account) which you can max out to fund medical bills. However, I am less excited about this one because your contributions don’t rollover. Maxing it out to the limit of $2750 is a great idea if you know you will have some exorbitant medical or dental bills to cover. And, some employers might let you carry it over.
6. If you work for the Government, use your 457 B
The 457 B is kind of like a 401K for state or local government workers. With a 457B plan, you can contribute up to $19,000 per year and reduce your taxable income by that amount – exactly the same as with the traditional 401k.
However, the benefit to a 457 plan is that you don’t need to wait until the age of 59.5 to withdraw that money. You can withdraw it at ANY age, upon retirement, with zero penalty.
The Government gives itself the sweetest deal on retirement accounts? Go figure.
7. Save Your Receipts for Medical Expenses, Education, and Donations
If you have gone back to school for an undergrad education, you may qualify for a tax break under the American Opportunity Tax Credit (AOTC). This only applies to the first four years of higher education. You must be enrolled at least half time, and if you qualify it is worth up to $2500 a student.
In comparison, the Lifetime Learning Credit has no limitation on how many years you have been enrolled, and isn’t confined to education that counts towards job skills or a degree. This credit is worth up to $2000. Learn more here.
Thanks to the new CARES act, after 2020 you can deduct up to $300 in cash donations as an above the line deduction.
Tax Deductions for Parents
As a parent, you can contribute college tuition to your state’s 529 plan. This won’t help you save on federal taxes, but it might help on your state return. Be wary that contributions over $15K might come with a gift tax penalty, so be strategic in how much you allocate.
Dependent Care FSA
If your employer offers it, you can contribute up to $10,500 to a Dependent Care FSA to lower your overall taxable income. You can then allocate these funds to everything from daycare to summer camp, and it might even cover elderly care depending on you’re employers plan.
Student Loans, House Purchases, and Selling Stocks
By the way, there are lots of other strategies to reduce your tax bills that include things like buying a house, incurring student loan debt, or selling stock losers.
While you should look into these things if they apply to you, none of them should be based solely on reducing your tax bill, which is why I don’t advocate for them here.
How it Adds Up
- $12,000 – Standard Deduction
- $19,000 – Traditional 401k / 457
- $6,000 – Traditional IRA
- $3,500 – HSA Plan
Total : $40,500 Reduction
Potential Savings: $10,000+
Why Taxes are Kinda Out of Control
Know that I don’t hate taxes for taxes sake. But what really rubs me the wrong way is how complicated they are. No person with an average college education could even hope to understand the insanely complex tax jargon and codes as they exist today.
Wherever you might stand politically, a complicated tax system is extremely problematic for the growing class divide.
Because only people who can afford to pay for professional help will receive the best tax breaks and benefits. Those unable to pay for tax services are subject to pay more on taxes or worse are slapped fines and audits of doing it incorrectly on their own. It’s a big problem.
Are taxes are confusing by design, to keep everyone terrified of doing it wrong and therefore faithfully paying H&R Block and TurboTax every year to spare them a headache, audit, fines, or jail?
And, can we be honest for a few seconds? The Government already knows how much you make because it is reported to them by your employer. So then why do you need to go do a bunch of complicated equations and paperwork to tell them what they already know?
Do you agree or disagree? Let me know in the comments.
How to pay less taxes with a Business or Side Hustle
I hope you enjoyed this rant and education on legal tax loopholes. But this is just the tip of the iceberg.
Why? Because the United States LOVES corporations. So much so, that they’ve granted them individual rights. Large corporations have lobbied for and won all kinds of tax avoidance perks over the years. That means, if you start your own business, you can get some of these perks too.
I don’t make the rules. I just learn ‘em and profit.
Stay tuned for next episode in which I will enlighten you on all of the interesting opportunities on how to pay less taxes by starting a business or a side hustle.