Savvy Ways to Lower Your Tax Bill
When the clock strikes midnight on New Year’s Eve, time’s up for many of the money moves you can take to lower your tax bill. Generally, for something to impact the tax return you're preparing this year, it needs to happen in the previous year.
However, there are a few last-minute things you don’t want to miss — or overlook — before filing your taxes.
Save for Retirement with an IRA
The first option is perhaps the most well-known. If you have (or open) an individual retirement account (IRA), you can choose to make your contributions up until the April 15 tax filing deadline. To do so, you elect to have the money counted as a contribution for the past tax year (make a contribution on April 1, 2021, but count it as part of your 2020 tax return, for example), which is often an option when you electronically transfer the funds to your IRA.
If you have a traditional IRA, you may be able to deduct your contributions from your income when you file your tax return, which can lower your tax bill this year. You’ll need to add the contributions and earnings to your income when you start taking withdrawals from your IRA — ideally, after you turn 59 ½, or you may have to pay a penalty.
Alternatively, you could contribute to a Roth IRA. Your contributions aren’t tax deductible, and won’t save you money now. But once you turn 59 ½, you can withdraw both your contributions and the earnings from your account tax-free. If you’re in a low tax bracket now, or expect your tax rate to be higher in the future, a Roth IRA may make more financial sense in the long run.
There are contribution and deduction limits Saver’s Credit for their retirement account contributions.
Tax credits are more valuable than deductions, as each $1 in credit lowers your tax bill by $1. A $1 deduction lowers your taxable income by $1, which may only lower your tax bill by 10 to 37 cents, depending on your tax bracket.
Build Your Medical Savings with an HSA
A Health Savings Account (HSA) is another type of tax-advantaged account that allows you to contribute up until the tax-filing deadline. An HSA is similar to an IRA in that the contributions can lower your taxable income.
The money in an HSA is intended for medical expenses, rather than general expenses during retirement. However, some people use an HSA as an additional (or alternative) retirement accounts because of its triple-tax advantages.
You can deduct contributions (like a traditional IRA), invest the funds tax-free, and then withdraw all your money tax-free (like a Roth IRA), if you use the funds for a qualified expense. These can range from prescriptions, vaccines, and tests to medical equipment and copays or deductibles, which are an inevitability as you age. You can also choose to pay for qualified expenses with non-HSA funds now and use the receipt to withdraw money from your HSA later — allowing your HSA to grow in the meantime.
However, you will pay a penalty if you withdraw money from your HSA without a qualified medical or dental expenses. Additionally, to qualify for an HSA, you need to have a annual contribution limits for HSAs.
Don't Miss Deductible Business Expenses
You don’t need to run a formal business or storefront to qualify for small business deductions. If you have a business deductions you’re allowed to take.
For example, if you got work through a rideshare or delivery app, you may be able to get a deduction for each mile you drove while working. The apps may help you track some of the business expenses, but they might not catch everything. If you buy snacks or water for passengers, make sure you keep the receipts as those could be business expenses. Additionally, a portion of your cellphone bill might be deductible as a business expense.
Other contract, freelance, or side gigs can also result in deductible business expenses. If you buy or make products to sell online, you could deduct your expenses from your business revenue. Or, perhaps you bought a computer that you use exclusively for contract work online — don’t forget to write that off.
Claim Energy Tax Credits
If you’re a homeowner and you made energy-efficient upgrades to your home, you may be eligible for state and federal energy tax credits. The upgrades could include added solar panels or a solar-powered water heater, and the federal credit could be worth up to 30% of what you spent on the equipment and installation. You may have known about the tax credit already, as these are often expensive investments, but don’t forget to claim it when you file.
Get Your Taxes Prepared and Filed for Free
Paying your taxes and paying for tax preparation and filing often go hand-in-hand. However, most taxpayers qualify for free tax preparation and filing.
If you want to do your taxes at home on your computer, look into the software options from the tax preparation software companies, including TurboTax and H&R Block. Federal tax return filing is also included, and some options come with free state filing as well.
To qualify for Free File Alliance software, your adjusted gross income (AGI) can’t be higher than $72,000 in 2020, which means the majority of tax filers can use these free options. However, some software options may have lower AGI limits, or may offer free preparation but require you pay to file your state tax return.
If you’d prefer in-person help, the IRS’s Volunteer Income Tax Assistance (VITA) program offers free tax preparation, federal, and state filing for households who made $57,000 or less. There are VITA sites around the country where you can find trained volunteers who will prepare and file your tax return for you. Sometimes, you can even drop off your paperwork rather than sitting with the preparer.
What If You Receive a Small Refund or Owe Money
In spite of doing everything you can to lower your tax bill, you might wind up with a smaller refund than you expected. Or worse, a large tax bill that’s difficult to repay. Even if you don’t like the numbers, make sure you at least file your tax return by April 15, or apply for an extension. Otherwise, you may have to pay a penalty for filing late.
There are also penalties and fees for failing to pay your full tax bill on time. However, you can get on a repayment plan with the IRS, and it’s often a relatively easy process. You can even apply online if you owe $50,000 or less — or, $100,000 or less if you’re applying for a short-term plan. Getting on a repayment plan can reduce the penalty you’ll pay, although you’ll still pay interest on the past-due amount.
If you’re worried about paying taxes and your household budget, consider scheduling a free debt and budget counseling session with a certified counselor. The counselor may be able to help you free up room in your budgeting by finding ways to lower your expenses or better manage your debts.