Paying tax liability is a common source of frustration for many Americans. It's common to feel angry when looking at your paycheck and realizing how much goes to the government towards a tax bill. However, paying income taxes is a necessary responsibility for all tax-paying citizens. Fortunately, tax deductions and credits can help alleviate the burden during tax season.
Filing your taxes strategically is essential to optimize your tax refund and tax savings. Taking advantage of all the tax credits you qualify for is vital.
Additionally, you should ensure no mistakes on your tax form that could result in additional costs. To avoid this, the following strategies can help you maximize your tax deductions, reduce your taxable income, and receive the largest tax refund possible in 2023.
Reduce your tax implications and save on taxes with these expert tips
1. Don’t be late on filing your taxes
To avoid facing significant fines, it's crucial to file federal income taxes or request an extension by April 18, 2023. State tax filing deadlines may vary, so verifying with your state's revenue department is advisable.
If you cannot complete your tax return within the tax filing deadline, you should file Form 4868 by April 18, 2023. This form extends the filing deadline until October 16, 2023. When filling out the form, you must provide a fair estimate of your tax liability for 2022 and pay any outstanding balance. Requesting an extension promptly is particularly important if you owe taxes to the IRS.
If you file and pay your taxes after the tax filing deadline, you may incur a late-filing penalty of 5% per month of the tax owed. Also, you must pay a late-payment fine of 0.5% per month of the tax due. The maximum late filing penalty is 25%, and the late-payment penalty tops at 25%. By submitting Form 4868, you can stop the clock running on the costly late-filing penalty.
2. Choose an e-filing method to pay taxes
Electronic filing is the most advantageous method to pay taxes and anticipate a tax refund as it is processed quicker than paper filing. As a result, you might receive refunds three to six weeks earlier. Opting for a direct refund deposit into a bank account or IRA further reduces the waiting time.
Aside from speedy refunds, there are other benefits to e-filing, including the IRS checking the return for completeness, increasing the likelihood of filing an accurate return. E-filing has a lower error rate of less than 1% compared to paper filing, which has an error rate of 20%. Moreover, unlike paper filing sent by certified mail, the IRS acknowledges receipt of the e-filed return. This helps to safeguard against interest and penalties if the paper return gets lost.
If an amount is owed, one can still file electronically and make payment through a check along with Form 1040-V, pay through a credit card, or direct debit. Credit card payment typically attracts a service charge of up to 2.5%, while direct debit may delay the debiting of the bank account until the actual filing deadline.
3. Search and select the right tax forms
You may find and choose the appropriate tax forms directly online. The Internal Revenue Service (IRS) website offers a vast collection of forms and publications for viewing and downloading. You can search for documents dating back to 1980 by number or date. Additionally, the IRS can guide you to websites where you can obtain state-specific forms and publications for the tax year. If you prefer a hard copy, the IRS can also mail you the forms.
4. Organize your records for end-of-the-year tax time
The most tedious part of tax season is gathering all the necessary documentation for tax purposes. You'll need to compile a tax return from the previous tax year, this year's W-2s and 1099s, and various receipts.
If you need to pay federal income taxes or state income taxes, consider following these tips to make this process more manageable:
- Keep all mail received in January containing information, for example - W-2s, 1099s, and mortgage interest statements. Be cautious not to discard any tax-related documents, even if they appear unimportant.
- Gather receipts and information accumulated throughout the tax year regarding your investments, assets, savings account, and liabilities.
- Print a tax checklist to identify all the documents required to complete your tax return.
- Group similar documents from your flexible spending account or savings account and store them in separate file folders when there are enough papers.
5. Boost your contributions in retirement accounts to minimize taxable income
Contributions to traditional IRA, 401(k), or 403(b) accounts are usually made using pre-tax dollars, resulting in tax savings by reducing taxable income. If you haven't funded your retirement account for 2022, you can do so until the tax return filing due date, the deadline for contributions to a traditional IRA, deductible or not, and to a Roth IRA.
For those with Keogh or SEP accounts, if you have a filing extension until October 16, 2023, you can wait until then to add 2022 contributions. However, it is recommended not to delay making contributions to start tax-free compounding as soon as possible.
By making a deductible contribution, you can reduce your tax bill this year, and your contributions will compound tax-deferred, making it an excellent opportunity. For example, if you contribute $5,000 annually for 20 years in an investment with an average annual 8% return, your $100,000 contributions will grow to $247,000. However, the same investment in a taxable account would only reach approximately $194,000 if you're in the 25% federal income tax bracket (and even less if your state has a state income tax).
Specific criteria must be met to qualify for the full annual IRA deduction in 2022. If you are eligible to participate in a company retirement plan, you must have an AGI of $68,000 or less as a single filer or $109,000 or less in case you file jointly. However, suppose you are not eligible for a company retirement plan. In that case, your contribution is fully deductible as long as your combined gross income with your spouse does not exceed $204,000.
Contributing to a Roth IRA instead of a traditional IRA may not lower your 2022 tax bill, as Roth contributions are not tax-deductible. However, this retirement savings option could be the better choice because funds from a Roth IRA can be withdrawn tax-free during retirement. However, if you make withdrawals from a traditional IRA during retirement, it will be fully taxable.
For 2022, the maximum IRA contribution limit is $6,000, but if you are 50 or older by 2022, you can contribute up to $7,000. Self-employed individuals can make a maximum annual contribution of $61,000 to SEPs and Keoghs. To contribute the full Roth IRA limit, your yearly income must be $129,000 or less for singles or $204,000 or less for married couples filing jointly.
The amount you save from contributing to your IRA will vary depending on your contribution amount, the number of contribution years, and the income tax bracket. For example, you will save $1,500 in taxes the first year if you are in the 25% income tax bracket and make a deductible IRA contribution of $6,000. Over time, future contributions can save you thousands of dollars in tax deductions.
6. Get updated with the new rules on tax credits and tax deductions
A tax credit directly cuts off your tax bill by the same amount as the credit. Some credits are refundable, meaning if your credit exceeds your tax liability, you can receive a refund for the difference. However, most credits are not refundable.
On the other hand, a tax deduction helps you to lower your taxable income, thereby decreasing your tax bill. You can take either the standard or itemized deductions to reduce your taxable income. Beforehand, you may qualify for above-the-line deductions to calculate your adjusted gross income.
Both tax credits and deductions can significantly decrease your tax bill or increase your refund. Recently, the American Rescue Plan Act temporarily increased certain tax credits and introduced a new rule for charity deductions. Now that these programs are ending, reviewing the eligibility rules and deduction amounts are essential to see what is currently available.
Here are a few tax credits and a deduction to consider:
The Premium Tax Credit
The American Rescue Plan Act of 2022 expanded the eligibility for the Premium Tax Credit, which is a credit that helps individuals purchase health insurance through the marketplace. Taxpayers with household incomes above 400% of the federal poverty line can now qualify for this credit temporarily.
The Child Tax Credit
In 2021, eligible individuals could receive a temporary Child Tax Credit of up to $3,600 per child, half of the amount sent as monthly advance payments. However, in 2022, the Child Tax Credit will return to its pre-2021 amount of up to $2,000 per eligible child.
The Child and Dependent Care Credit
It is also known as CDCC and is designed to assist with daycare and other similar expenses for dependents, for example - kids under 13, a spouse or old parent who can't take care of themselves or other dependents that allow you to work. Typically, the credit covers up to 35% of expenses up to $3,000 for one dependent or up to $6,000 for two or more dependents. In 2021, the maximum credit was $8,000, but in 2022, the maximum credit was $2,100.
The 401(k) Contributions Deduction
The amount you contribute to a 401(k) directly from your paycheck is not taxed by the IRS. The contribution limit for 2022 was $20,500, or $27,000 if you were 50 or older. Employers typically sponsor these retirement accounts, although self-employed individuals can open their own 401(k)s.
Earned income tax credit
The Earned Income Tax Credit (EITC) can refund between $560 and $6,935 based on your number of children, marital status, and income level. It may be worth exploring if your Adjusted Gross Income (AGI) is less than approximately $59,000. The Earned Income Tax Credit (EITC) limit is lower this year than last, so check with the IRS for information on income eligibility and credits for 2022.
American opportunity tax credit
The American Opportunity Tax Credit (AOC) allows you to claim up to $2,000 of tuition, books, equipment, and school fees, plus 25% of the next $2,000, for a maximum credit of $2,500. This credit does not cover living expenses or transportation costs.
Deduction for state taxes and local taxes
You can deduct up to $10,000 ($5,000 if married filing separately) in combined property taxes and either state income taxes/local income taxes, or sales taxes. Check with the IRS for details on how the property tax and sales tax deductions work.
Lifetime learning credit
The Lifetime Learning Credit authorizes you to claim 20% of the first $10,000 you paid in tuition and fees, up to a maximum credit of $2,000. Like the AOC, this credit does not cover living expenses or transportation costs, but you can claim books or supplies required for coursework.
IRA contributions deduction
You may be eligible to deduct contributions to a traditional IRA. But the amount you can deduct might depend on whether you or your spouse has a retirement plan and income level.
Saver's credit
The Saver's Credit can give you a credit of 10% to 50% of up to $2,000 ($4,000 if filing jointly) in contributions to specific retirement plans, such as an IRA, 401(k), or 403(b). The percentage of the credit depends on your filing status and income level.
Student loan interest deduction
The student loan interest deduction helps taxpayers who paid interest on their student loans to deduct up to $2,500 from their taxable income.
Adoption credit
This item covers the adoption costs per child up to $14,890. When your 2022 modified AGI surpasses $263,410, the credit phases out and starts to drop gradually at certain income levels.
Donations to a charity
Only in 2021 were charitable contributions deductible as a specific line item, even if you claimed the standard deduction. You must itemize your deductions if you wish to deduct your qualified charitable distribution this year.
If you itemize, you may deduct the number of your charitable contributions from the taxable income, whether made in cash or in-kind items like clothing or a car.
According to the IRS, you may typically deduct up to 60% of the adjusted gross income through this maximum contribution.
Medical expenses deduction
Generally, eligible, unreimbursed medical expenses that exceed 7.5% of your adjusted gross income are usually deductible for the tax year.
Mortgage interest deduction
The mortgage interest tax deduction is promoted to lower the cost of homeownership. It reduces the federal income tax that eligible homeowners must pay by deducting the mortgage interest from their taxable income.
Gambling loss deduction
Only the winning amount is deductible for losses and expenses related to gambling. Hence, buying $100 worth of lottery tickets is not deductible unless you also win $100 and report it. You aren't allowed to make deductions more than your winning amount.
Health savings account contributions deduction
These accounts provide quadruple tax savings while enabling users to save money for medical expenditures. Health savings account contributions are tax-deductible, and withdrawals are tax-free if you use them to pay qualified medical expenses. A health savings account allows deductible contributions until the filing deadline, just like a standard IRA.
For the 2022 tax year, taxpayers with qualified family health insurance plans may deduct up to $7,300 in health savings account contributions, while those with qualified individual health insurance plans may deduct up to $3,650. Those 55 or older are qualified for an additional $1,000 in deductible contributions with either form of insurance.
Self-employment expenses deduction
Numerous worthwhile tax deductions exist for freelancers, contractors, and other independent contractors.
Home office deduction
The IRS allows you to deduct some self-employment deductions for connected rent, utilities, real estate taxes, repairs, maintenance, and other relevant expenses if you use part of your house often and exclusively for business-related activity.
Educator expenses deduction
Teachers and other qualified educators may deduct up to $300 from their classroom supply expenses in 2022.
Residential energy credit
The Inflation Reduction Act of 2022 may entitle you to a tax benefit for upgrades that boost your home's energy efficiency. Through the domestic energy credit, you can receive up to 30% of the cost of installing solar energy systems, such as solar water heaters and solar panels.
Additionally, the new law boosted the value of those credits and extended them through 2023. Save any receipts for purchases made for energy-efficient home modifications if you want to claim a credit for them in case the IRS has to confirm your eligibility.
Clean energy/electric vehicle tax credit
For the tax year 2022, the nonrefundable EV tax credit's range is $2,500 to $7500, and eligibility is based on the manufacturer, ownership status, and weight of the qualifying electric and plug-in hybrid vehicle. However, the eligibility requirements changed after the Inflation Reduction Act was passed in 2022.
The credit is significantly increased for the tax year 2023 and covers secondhand vehicles.
7. Opt for a 529 Plan
Consider opening a 529 plan for college savings if you have children or plan to return to school yourself. Although these contributions have no federal tax breaks, some states permit residents to deduct contributions from their state taxes.
Withdrawals from 529 accounts are tax-free if they're used for qualified education expenses. If your child doesn't go to college or doesn't require all of the funds, you can designate another beneficiary or use up to $10,000 to repay student loans.
In addition, there's now the option to transfer money from these accounts to individual retirement accounts.
8. Deduct Business Expenses
As a self-employed individual, business expense deductions can significantly reduce your taxable income, making them your best allies come tax time. You can deduct a broad range of expenses, including some of the most common ones:
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Home office deductions
You need to use a part of your home solely for your home office needs to be qualified for a home office deduction.
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Property rental deductions
If you rent a storefront to run your business from, you can claim a deduction for the year(s) you pay rent.
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Mileage deductions
You can deduct any mileage explicitly driven for business purposes, with a rate of 65.5 cents per mile in 2023 (62.5 cents per mile in the second half of 2022).
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Office supplies and materials deductions
Any office supplies and materials you use for business can be deducted, provided you keep receipts.
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Phone and internet bill deductions
Regular phone and internet bills for your business are also deductible.
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Travel expenses deductions
When traveling for business, you can deduct travel expenses such as flight costs, bus and train tickets, taxis, lodging, and meals.
9. Ask for deductions as a military service member
As an active member of the national military services, including the National Guard, you can deduct unreimbursed travel expenses like transportation, meals, and lodging if you travel more than 100 miles from home and require an overnight stay.
Additionally, as an active duty service member, you can deduct any expenses related to moving for a permanent change of station.
10. Go for long-term capital gains
Investing is valuable for building wealth through stocks, mutual funds, bonds, and real estate. But it can also provide an additional benefit of favorable tax treatment for long-term capital gains.
An investor who holds a capital asset for over a year can take advantage of a preferential tax rate (0%, 15%, or 20%) on the taxable capital gain, considering their income level. Short-term gains, on the other hand, are taxed at ordinary income rates. Understanding the difference between long-term and short-term capital gains rates is crucial for maximizing wealth growth.
For long-term capital gains, the zero rate bracket applies to taxable income up to $89,250 for couples filing jointly for 2023 (an increase from $83,350 in 2022) and $44,625 for single filers (raised from $41,675 in 2022). To minimize gains and maximize losses, a tax planner and investment advisor can help determine the optimal timing and method for selling appreciated or depreciated securities.
Another method of offsetting a capital gains tax burden by selling stocks at a loss is tax-loss harvesting. The lesser $3,000 of the excess or net capital loss may be deducted from other income if capital losses outweigh capital profits. Over $3,000 in capital losses may be carried over to subsequent tax years.
11. Pay a last-minute estimated tax payment
To avoid a potentially large tax bill and hefty interest and penalties, consider making a last-minute estimated tax payment if you didn't pay enough to the IRS throughout the year. The IRS requires you to pay either 100% of last year's or 90% of this year's tax, or you'll owe an underpayment penalty. For individuals with an adjusted gross income of over $150,000 in 2021, the required payment is more than 110% of their 2021 tax bills to avoid an underpayment penalty for the tax year 2022.
Paying an estimated tax by January 15th can eliminate the penalty for the fourth quarter, but penalties may still apply for previous quarters if you didn't make estimated payments then. However, if you receive an income windfall after August 31st, 2022, you can file Form 2210: Underpayment of Estimated Tax to annualize estimated tax bills and potentially reduce additional charges.
Avoiding overpaying is essential, as it's better to owe a small amount than expect a refund. Remember that the IRS doesn't pay any interest when borrowing your money.
12. Itemize your tax deductions
When you talk about the tax deduction, the standard deduction is more straightforward, but itemizing could result in significant savings, particularly if you're self-employed, a homeowner, or live in a high-tax location.
Itemizing becomes advantageous when your eligible expenses surpass the 2022 standard deduction of $12,950 for most single filers and $25,900 for most couples filing jointly.
Many tax deductions are widely recognized, such as those for mortgage interest and charitable donations, and you can also deduct qualified medical expenses that exceed 7.5% of your AGI income for 2022.
13. Consult with a new accountant
If you've been utilizing the same tax professional for years, having someone else examine your return might be beneficial. After a long time, a tax accountant may have grown accustomed to completing a client's return in a particular manner and may not actively seek cost savings.
A new accountant could conduct a more thorough review of your tax situation and, in some cases, amend prior returns to obtain larger refunds from previous years. Whether you utilize an accountant or do your taxes, remember that the tax code constantly evolves, and your savings opportunities may fluctuate yearly. So you need to understand the odds, stay updated, and probably hire an expert who can take care of your tax implications, know every tax break and tax benefits, know about standard deduction and itemized deduction, calculate and lower taxable income, and increase your tax savings.
Conclusion
To minimize your tax burden, you can access many deductions. These deductions cover a range of areas, including investments, student loans, retirement accounts, and health insurance plans. With the help of these deductions, you can reduce your taxable income by thousands, resulting in significant tax savings yearly. So, paying close attention to these deductions is crucial.
