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While you might not be able to escape paying any taxes, some strategies can minimize how much you'll owe. There are a few moves that you can do right up to this year's tax-filing deadline, and more than can help you save money when you file next year.
1. Make Tax-Deductible Contributions
There are several types of tax-advantaged accounts you can use to save for the future while reducing your tax bill today:
- 401(k)s and 403(b)s: Employer-sponsored retirement accounts you may be able to open through your work.
- Individual retirement arrangements (IRAs): Retirement plans you can open regardless of where you work.
- Health savings accounts (HSAs): Accounts you can use to set aside money for eligible medical expenses, but only if you have a high-deductible health plan and meet the other requirements.
- Flexible spending accounts (FSAs): Use-it-or-lose-it accounts that can offer tax savings on eligible medical or dependent care expenses, but can only be opened through an employer.
- 529 plans: Accounts you can use to save and invest for educational expenses for yourself or somebody else, and potentially receive a tax break on your state tax return.
Many of these accounts offer tax-deferred benefits, meaning you'll get a tax break now, but may have to pay taxes on the money when you withdraw it in the future. If you don't withdraw the money until you retire, you may be in a lower tax bracket and pay less income taxes. In the meantime, you can invest the money in most of these accounts and benefit from tax-free compound growth.
You also may have the option of making contributions to IRAs and HSAs up to the tax filing deadline for the year. For example, if you make a contribution in March 2022, you can decide if you want to count it as a contribution for 2021 or 2022. But don't contribute more than your annual limit for the year.
If you're in a low tax bracket today, Roth retirement accounts, such as a Roth 401(k) or Roth IRA, could be a good alternative. Your contributions won't reduce your taxable income today, but you won't pay income taxes on any of the qualified withdrawals in the future.
2. Claim Tax Credits
Tax credits can be more valuable than tax deductions because credits lower your taxable income on a dollar-for-dollar basis.
For example, if you receive a $100 tax credit, you'll pay $100 less in taxes. And if it's a refundable tax credit, like a portion of the earned income tax credit is for some taxpayers, you'd get that extra $100 in your refund.In contrast, tax deductions lower your taxable income. For example, if you're in the 22% tax bracket and receive a $100 deduction, your tax savings will only be $22. Deductions are never refundable.
There are many tax credits available, each with their own rules and requirements. Consulting a tax preparation professional or using tax preparation software can help you identify and claim the tax credits you qualify for.
3. Hold Investments for a Year
If you're investing in taxable accounts, keep track of when you first purchase an investment. When you quickly buy and sell investments—including stocks, mutual funds, exchange-traded funds (ETFs) and cryptocurrencies—any profits you make are considered short-term capital gains. These are taxed at the same rate as your regular income.
However, if you hold an investment for more than a year before selling, your profits are taxed as long-term capital gains—and the capital gains tax rates can be much lower. For the 2021 tax year, the capital gains tax rate is 0% if you're single and your taxable income is less than $40,400 ($41,676 for 2022), or married filing jointly and have a combined taxable income under $80,800 ($83,351 for 2022).
4. Look for Tax-Free Investment Opportunities
There are also a few investments that offer tax-free gains, even if you don't purchase them in a tax-advantaged account.
For example, interest from municipal bonds—a loan you extend to local and state municipalities—might be exempt from federal taxes. You may also be able to avoid local and state taxes on the interest earnings if you buy a municipal bond from an entity in the state where you're living.
Inflation-linked saving bonds, also called I-bonds, are another option, although the interest earnings are only exempt from local and state taxes. These have become popular as inflation rates rise because I-bonds' yields typically rise when inflation is high. Additionally, you could look into tax-exempt mutual funds and ETFs.
5. Learn About Business Write-Offs
If you have a business, worked as a freelancer, had a side hustle or were a contractor (in other words, you received a 1099-NEC), the IRS may consider you a self-employed business owner. As a result, you may be able to write off business expenses, which can decrease your tax bill because you won't have to pay income or self-employment taxes on that money.
The rules for what you can deduct can be complicated, and it can vary depending on your business. But it's worth learning more if you run a business or have a side hustle.
For example, if you're a delivery or rideshare driver, you may be able to deduct 56 cents per business mile you drove in 2021 (and 58.5 cents per mile you drive in 2022). For regular drivers, this can add up to hundreds or thousands of dollars in deductions. However, you'll need to understand the difference between commuting miles and business miles to accurately claim the deduction.
Don't Pay More Than You Have To
When you do go to prepare and file your taxes, look into the free preparation and filing options. Most taxpayers are eligible to use free tax preparation software through the Free File Alliance, or you may qualify for free one-on-one preparation and filing through the IRS's Volunteer Income Tax Assistance and Tax Counseling for the Elderly programs.