Legally Minimize Taxes: Strategies For Savvy Citizens

Paying taxes is a complicated process, and while it's not voluntary, there are legal ways to reduce your tax bill. This is called tax avoidance, and it involves taking advantage of tax deductions, credits, and other incentives to lower your taxable income. These methods are entirely lawful and can help taxpayers minimize their tax liabilities. On the other hand, tax evasion is illegal and involves deliberately hiding income or falsifying financial information to avoid paying taxes.

Make use of tax credits and deductions

Making use of tax credits and deductions is a legal way to reduce your tax bill. Tax credits and deductions are available for both individuals and businesses.

Tax Credits

Tax credits directly reduce the amount of tax you owe. There are 17 tax credits for individuals offered by the IRS, which fall into five categories:

• Homeownership and real estate credits
• Income and savings credits
• Health coverage tax credits
• Retirement savings contribution credits
• Education tax credits

Tax Deductions

Tax deductions reduce the amount of taxable income. The IRS offers standard and itemized deductions. Most people take the standard deduction, which lets you subtract a set amount from your income based on your filing status. For 2024, the standard deduction is:

• $14,600 for single or married filing separately
• $29,200 for married couples filing jointly or qualifying surviving spouse
• $21,900 for head of household

If your deductible expenses and losses exceed the standard deduction, you may benefit from itemized deductions. These are expenses that you subtract from your income when you file your taxes so that you don't pay tax on them. Itemized deductions include:

• Business use of your car
• Business use of your home
• Money you put in an IRA
• Money you put in health savings accounts
• Penalties on early withdrawals from savings
• Student loan interest
• Moving expenses for military servicemembers
• Canceled debt on home
• Donations to charity
• Gains from the sale of your home
• Home mortgage interest
• Income, sales, real estate, and personal property taxes
• Losses from disasters and theft
• Medical and dental expenses over 7.5% of your adjusted gross income
• Miscellaneous itemized deductions
• Opportunity zone investment

Contribute to a retirement plan

Contributing to a retirement plan is one of the easiest ways to legally avoid paying too much in taxes. Here are some detailed instructions on how to do this:

Individual Retirement Account (IRA)

If you are an American citizen, one way to contribute to a retirement plan is to put money into an Individual Retirement Account (IRA). This allows your investments to grow tax-free until you withdraw them during retirement. There are different types of IRAs, each with its own rules and tax benefits. Traditional IRAs, for example, allow you to make tax-deductible contributions, while Roth IRAs offer tax-free withdrawals in retirement. You can choose the type of IRA that best suits your financial goals and tax situation.

K) Plan

Another option for retirement savings is to contribute to a 401(k) plan, if your employer offers one. This is a tax-advantaged plan that allows you to save and invest a portion of your salary for retirement. Contributions to a traditional 401(k) are made before taxes, lowering your taxable income. Some employers also offer Roth 401(k) plans, which are similar to Roth IRAs, where contributions are made after taxes but withdrawals in retirement are tax-free.

Health Savings Account (HSA)

In addition to retirement plans, you can also save for medical expenses by contributing to a Health Savings Account (HSA). This is a tax-advantaged account that allows you to pay for qualified medical expenses with tax-free dollars. To be eligible for an HSA, you need to be enrolled in a high-deductible health plan. Contributions to your HSA can be made before taxes, and the funds can be used to pay for a variety of medical expenses, including deductibles, copayments, and coinsurance.

Self-Employed Retirement Plans

If you are self-employed, there are also several retirement plan options available to you. These include Solo 401(k) plans, Simplified Employee Pension (SEP) IRAs, and SIMPLE IRAs. These plans offer tax advantages similar to those of traditional 401(k) and IRA plans, but they are designed specifically for self-employed individuals and have different contribution limits and rules.

Remember, it is important to consult with a financial advisor or tax professional to determine which retirement plan options are best for your specific situation. They can help you navigate the rules and regulations associated with each type of retirement plan and ensure that you are taking advantage of all available tax benefits.

Donate to charity

Donating to charity is a great way to contribute to society and save money on your taxes at the same time. It's a win-win situation, but it's important to follow the rules and keep careful records to substantiate your donations and maximize your tax advantages.

Rules for Donating to Charity

• Designated Charities: Ensure that the charity you donate to is designated as a 501(c)(3) organization by the Internal Revenue Service (IRS). Not all tax-exempt organizations have this status.
• Itemized Deductions: To claim deductions for charitable donations, you will typically need to itemize your deductions on your tax return instead of taking the standard deduction.
• Deduction Limits: The amount you can deduct is usually limited to a certain percentage of your adjusted gross income (AGI). For individuals, this limit is typically 50% or 60%, but in some cases, it can be lower, such as 20% or 30%.
• Carry Forward Deductions: If you can't use all your deductions in one year, you can carry them forward for up to five years. However, be sure to use the older deductions first to avoid losing them after the five-year limit.
• Proof of Donations: Keep donation receipts and other proof of your charitable contributions. For cash donations of $250 or more, you will need written acknowledgment from the organization. For non-cash donations, you may need to provide additional documentation, such as a written receipt or an IRS form.

Types of Donations

You can donate to charities in various forms, and each type of donation may have specific rules and limitations.

Cash Donations

Cash donations typically refer to monetary contributions made by check, credit card, or electronic funds transfer. These donations are generally tax-deductible up to the limits mentioned earlier.

Non-Cash Donations

Non-cash donations include donations of goods, such as clothing, household items, vehicles, and other property. These donations are typically deductible at the fair market value of the items at the time of donation, not their original purchase value. Non-cash donations may have additional documentation requirements, as mentioned earlier.

Securities and Investments

Donating long-term appreciated securities (such as stocks, mutual funds, or bonds) and other investments can be a tax-efficient way to give to charity. By donating these assets directly to a charity, you can eliminate capital gains taxes and increase your tax deduction and charitable contribution.

Retirement Accounts

If you are a freelancer or self-employed, consider contributing to a retirement account, such as an Individual Retirement Account (IRA) or a Roth IRA. These contributions may be tax-deductible and can help lower your taxable income.

Strategies for Maximizing Tax Benefits

To maximize your tax benefits when donating to charity, consider the following strategies:

• Strategize Your Giving: Plan your charitable giving to align with years when you expect to be in a higher tax bracket. This way, you can take advantage of a larger deduction.
• Combine Cash and Securities: If you plan to donate securities, consider combining them with a charitable contribution of cash to create a larger current-year deduction.
• Donor-Advised Funds: Consider using a donor-advised fund, which allows you to contribute cash or other assets, take an immediate tax deduction, and then recommend grants to your preferred charities over time. This provides flexibility in the timing and number of charitable causes you support.
• Offset Capital Gains: If you routinely rebalance your investment portfolio, consider donating appreciated securities instead of selling them. This can help you avoid capital gains taxes and still allow you to rebalance your portfolio.

Remember, always consult with a tax professional or financial advisor to ensure you are following the latest rules and regulations and to maximize your tax benefits when donating to charity.

Claim child tax credits

Claiming child tax credits is a way to reduce your tax bill without breaking the law. The Child Tax Credit (CTC) is a tax credit for parents and guardians with dependent children. In 2024, the CTC is worth up to $2,000 per qualifying dependent child, with a refundable portion of up to $1,700. The credit is available to those who meet certain eligibility criteria and have an annual income below a certain threshold ($200,000 for individuals and $400,000 for joint filers). To claim the CTC, you must complete Form 1040, U.S. Individual Income Tax Return, and attach Schedule 8812, Credits for Qualifying Children and Other Dependents.

To be eligible for the CTC, your dependent must meet the following criteria:

• Be under 17 at the end of the tax year.
• Be your son, daughter, stepchild, eligible foster child, brother, sister, stepbrother, stepsister, half-brother, half-sister, or a descendant of one of these (e.g., a grandchild, niece or nephew).
• Not provide more than half of their own financial support for the tax year.
• Have lived with you for more than half the tax year (with some exceptions).
• Be claimed as a dependent on your tax return.
• Not file a joint return for the year (unless it is to claim a refund of withheld or estimated taxes).
• Be a U.S. citizen, U.S. National, or a U.S. resident alien with a valid Social Security number.

It is important to note that the CTC is subject to income phaseouts. For individuals with a modified adjusted gross income (MAGI) above $200,000 or joint filers with a MAGI above $400,000, the credit amount is reduced by $50 for every $1,000 above the threshold. Additionally, parents and guardians with higher incomes may still be eligible for a partial credit.

If you are eligible for the CTC but cannot take full advantage of it because you do not owe enough taxes, you may be able to claim a partial refund by claiming the Additional Child Tax Credit (ACTC). The ACTC allows you to receive a refund for a portion of the unused CTC. To claim the ACTC, you must meet the eligibility criteria for the CTC and have an earned income of at least $2,500.

By strategically utilizing the CTC and ACTC, parents and guardians can reduce their tax liability and maximize their tax refund. It is important to carefully review the eligibility criteria and income thresholds to ensure compliance with the requirements for claiming these tax credits.

Move to a different country

Moving to a different country is a way to legally avoid paying taxes in your home country. However, it is important to note that this strategy may not always be effective, as some countries have different tax rules and regulations. For example, the United States taxes its citizens based on citizenship rather than residence, so US citizens living abroad are still required to file US tax returns and report their worldwide income. Hence, it is crucial to understand the tax laws of both your current country of residence and the country you are considering moving to.

• Tax Treaties: Research the tax treaties between your current country of residence and the country you are considering moving to. Tax treaties can help you avoid double taxation and take advantage of tax incentives in certain countries.
• Foreign Earned Income Exclusion (FEIE): If you are a US citizen, the FEIE allows you to exclude a certain amount of foreign-earned income from US taxation. For 2024, the FEIE is capped at $126,500 per person. This strategy falls under the Physical Presence Test, which requires you to reside outside the US for at least 330 days out of 365.
• Foreign Tax Credits: You may be able to claim foreign tax credits if you pay taxes in the country you move to. Foreign tax credits provide a dollar-for-dollar reduction on your US taxes for income taxes paid to a foreign government.
• Foreign Housing Exclusion: When renting a home in another country, you may be able to deduct certain expenses from your US taxes.
• Tax Residency: Understand the criteria for tax residency in the country you are considering moving to. Some countries may require you to spend a certain number of days in the country to be considered a tax resident and qualify for tax benefits.
• Cost of Living: Consider the cost of living in the country you are moving to. Some countries with a lower cost of living may have lower tax rates or allow you to keep yourself in a lower tax bracket, reducing your overall tax burden.
• Tax-Free Countries: Consider moving to countries with no income tax, such as Bahrain, Monaco, or the Bahamas. However, keep in mind that even if you live in a tax-free country, you may still have tax obligations in your home country.
• Expatriation: If you are a US citizen, consider formal expatriation by renouncing your citizenship or relinquishing your green card status. This option can eliminate all US taxes and IRS reporting obligations. However, be aware of potential exit taxes and the costs associated with renouncing your citizenship.
• Tax Planning: Consult with a tax professional or an international tax specialist to create a comprehensive tax plan. They can help you understand the tax laws of different countries and advise you on the best strategies to legally reduce your tax burden.

Frequently asked questions