published 2023-01-13 13:00:00 7 How to Avoid Taxes Legally /content/thumbnails/p-50-how-to-avoid-taxes-legally-1-small.webp how-to-avoid-taxes-legally Welcome to the world of tax strategy - the world where the difference between tax avoidance and tax evasion is the difference between being a money-wise person and a criminal. Let's explore the legitimate ways to reduce your taxes so you can keep more of your hard-earned money in your pocket.

How to Avoid Taxes Legally

Welcome to the world of tax strategy - the world where the difference between tax avoidance and tax evasion is the difference between being a money-wise person and a criminal. Tax avoidance is the legal act of minimizing your tax liability and maximizing your after-tax income. Tax evasion is the illegal act of failing to pay or deliberately underpaying your taxes. Let's explore the legitimate ways to reduce your taxes so you can keep more of your hard-earned money in your pocket.

How to Avoid Taxes Legally

Use Tax-Free Dollars on Commuting Costs

Commuter benefits are a little-known treasure trove for savvy tax planners. By taking advantage of these benefits offered by your workplace, you can spend up to $300 per month tax-free on commuting expenses, effectively giving you a $300 tax deduction every month. That's a whopping $3,600 in tax deductions per year! You can save annually by not having to pay taxes on that amount.

You can use your pre-tax dollars on mass transit (trains, subways, and buses) and parking expenses at meters, garages, and lots. You can even use your commuter benefits funds to pay for ride-sharing services like Lyft Line or UberPOOL. Note that you cannot use the benefits for regular Lyft or Uber rides.

Don't miss out on this opportunity to make your daily commute more affordable. Ask your employer if they have a commuter benefit program.

Put Your Money Into Your HSA

Putting money into your HSA is another way to reduce your taxes. A Health Savings Account (HSA) is available to those with a high-deductible health plan and allows them to set aside money for health-related expenses. The beauty of an HSA is that you can pay for healthcare with pre-tax dollars because any money you spend from the account on qualified medical expenses is not subject to taxes.

But the benefits don't stop there. You can invest your HSA funds and any earnings or interest will also be tax-free. Not only are you saving on taxes now, but you could also be growing your savings for future healthcare expenses tax-free.

Learn more: Health Savings Account (HSA): Become Financially Healthier

Use the Tax Benefits of a 529 Plan

If you're looking to save money for education, whether it's for your child, someone else, or even yourself, a 529 plan is a great option. Although you won't receive a tax deduction from the IRS for funding a 529 plan, you may be eligible for a tax deduction on your state's income taxes.

Some states, such as California, do not offer a tax deduction for 529 plan contributions. Also, nine states do not have state income taxes at all. Check with your state before setting up a plan. But even if your state doesn't offer a tax deduction or doesn't have state income taxes, you can still benefit from tax-free growth with a 529 plan. You won't have to pay taxes on any interest, dividends, or capital gains earned on the investments within the plan.

Maximize Tax Benefits by Holding Investments Long-Term

You can take advantage of more favorable tax treatments by holding your investments for longer. Be aware of the difference between long-term and short-term capital gains. Long-term capital gains - profits from selling an investment you've held for more than a year - are subject to more favorable tax treatment than short-term capital gains.

If you are in a higher tax bracket, the tax rate for long-term capital gains is significantly lower than that of short-term capital gains. Short-term capital gains are profits from selling an investment that you've held for less than a year. Short-term gains are taxed at your ordinary income tax rate. If you are in a lowers tax bracket under a certain income threshold, you may qualify for a zero percent tax rate at the federal level.

Offset Taxable Gains with Losses

Investing is a risky business, and while it can yield capital gains, it can also result in capital losses. However, even in the face of losses, there are opportunities to minimize your tax burden.

You can use tax loss harvesting - a strategy to offset capital gains with capital losses. It's a simple concept - when you sell an investment at a loss, you can use that loss to offset any profits on other investments.

Your brokerage typically accounts for all your losses on the 1099B tax form you receive at the year's end. But losses from other investments, such as cryptocurrency, are easy to overlook. Don't forget to report your losses to avoid paying unnecessary taxes.

Contribute to Tax-Advantaged Retirement Accounts

If you want to reduce your taxes, one of the most effective ways is by contributing to tax-advantaged retirement accounts. These include traditional and Roth versions of 401(k), 403b, and IRA accounts. When you contribute to these accounts, the money you put in is either tax-deferred or tax-free, depending on the type of account, and you can save on taxes either now or in the future.

Tax-deferred retirement accounts allow you to reduce your taxable income by a certain amount. This amount will not be subject to income tax at the time of contribution. Here is a very simplified example: if you earn $40,000 a year and contribute half to a tax-deferred account, you will have to pay taxes only on $20,000 instead of $40,000. Moreover, the money continues to grow tax-free until you withdraw it.

You will eventually have to pay taxes when you withdraw the money in retirement. You may be in a lower tax bracket when you retire than you are now and pay less in taxes. But the real power of tax-deferred accounts lies in the fact that the money you didn't pay in taxes will work for you for many years. By contributing pre-tax dollars to a traditional 401(k) or IRA, you're allowing that money to compound over time, growing at a potentially faster rate than if you had invested post-tax dollars. By the time you retire, that money you didn't pay in taxes could have grown into a significant nest egg.

Tax-free accounts include Roth 401(k)s and Roth IRAs. The difference between these and traditional tax-deferred accounts is that the money you put in is already taxed, but the money in the account grows tax-free, and when you withdraw the money during retirement, you won't have to pay taxes on it. Tax-free accounts are best if you expect to be in a higher tax bracket in retirement than when you were working.

Be aware of the limits on how much you can contribute to these accounts each year, and remember that if you withdraw money before retirement age, it will be subject to penalties.

Related Articles

Subscribe to Our Newsletter