15 Legal Ways to Pay Less in Taxes and Keep More of Your Money

Taxes are difficult to avoid and seem to occur everywhere—on our paychecks, our property, and nearly every purchase. But there are credits, deductions, and strategies that can legally help us reduce our taxable income, and pay less in taxes.

It’s important to know your options and retain more of what’s rightfully yours.

1. Max out IRA and Employer Retirement Contributions

Take advantage of the tax benefits offered by the IRS through qualified retirement plans. Whether you’re looking to save on taxes today or in the future, these accounts help.

2023 Contribution Limits

401k: Standard limit of $22,500. For those over 50, it increases to $30,000 – known as catch-up contributions.

IRAs: Standard limit is $6,500, rising to $7,500 for those above 50.

Contribution Types

Things to Keep in Mind

• Predicting the Future: It’s challenging to determine which contribution type will be most beneficial long-term due to uncertainties about future tax brackets.
• Employer Plan Restrictions: Not all employer-sponsored plans accept post-tax contributions. Check your plan or ask HR to be sure. And if not, consider utilizing a Roth IRA for post-tax contributions.
• Annual Limits Matter: The IRS sets caps on yearly contributions: if you don’t hit these limits in a particular year, there’s no going back. It’s a missed opportunity.

2. Leverage Child Tax Credits

Children can be expensive, but the IRS offers tools to ease the burden. The Child Tax Credit and the Child Care Tax Credit are two distinct credits available to eligible taxpayers.

For a parent with two children, this translates to potential savings of up to $6,100 in 2023.

Child Tax Credit (CTC)

What is it? The CTC aids families by offering tax reductions based on the number of qualifying children they support.

What’s the Benefit? For 2023, each qualifying child can trim up to $2,000 off a family’s tax liability. In some cases, it might even lead to a refund.

Things to Note: This credit diminishes for households with a modified adjusted gross income surpassing $400,000 (for married couples filing jointly) or $200,000 for all other filers.

Child Care Tax Credit

What is it? This credit assists parents by covering a portion of child care costs, facilitating their ability to work or seek employment.

What’s the Benefit? For the 2023 tax year, eligible families can receive a credit that ranges from 20% to 35% of their child care expenses. This could result in a maximum credit of $1,050 for one child or $2,100 for two or more children.

Things to Note: The credit calculation involves expenses up to $3,000 for one child or $6,000 for two or more. Proper documentation of these expenses is crucial to ensure full credit eligibility.

Read More: 12 Top Tax Deductions: Food, Travel, Spending, and More

3. Look into the earned income tax credit (EITC)

The EITC is a refundable tax credit aimed at benefiting working individuals and families with low to moderate income.

What’s the Benefit?

For 2023 the earned income credit ranges from $600 to $7,430, depending on your filing status and the number of children you have.

Who Qualifies?

Depending on your filing status and the number of children, the EITC offers the following benefits:

Things to Note:

• Income Limits: Your income must not exceed the limits mentioned in the table above based on your filing status and number of children.
• Investment Income: Exceeding a certain investment income limit in a year can disqualify you.
• Employment: You need to have earned income, either from employment or a self-run business.

4. Contribute to Health Savings Accounts (HSA)

Do you have a High Deductible Health Plan (HDHP)? If so, you might be overlooking one of the most significant tax-saving tools: the Health Savings Account (HSA).

Leveraged correctly, HSA contributions can be invested for growth, and potentially never taxed, offering tremendous value in your financial planning.

2023 HSA Contribution Limits

Individual Coverage: If you have an HDHP only for yourself, the contribution cap for 2023 is $3,850.

Family Coverage: For those with family coverage under an HDHP, the maximum contribution is set at $7,750 for 2023.

What Makes an HSA so Special?

Imagine Sarah, who’s 30 years old and every year, she contributes the maximum allowable amount to her HSA. Rather than spending this money on current medical expenses, she chooses to invest her HSA contributions, allowing them to grow.

Fast forward 35 years. Sarah is now 65 and ready to retire. Over the years, thanks to the power of compound interest, her HSA has grown substantially, far more than just the sum of her contributions.

The best part? Every step of this journey is tax-free. When Sarah made contributions, that money wasn’t taxed. As her investments grew, those earnings weren’t taxed either. And now, as she begins to withdraw from her HSA for medical expenses, that too is tax-free. Triple tax advantage!

5. Align FSA Contributions with Expected Medical Expenses for Maximum Savings

Flexible Spending Accounts (FSAs) offer an excellent way to save on taxes by allowing you to set aside pre-tax dollars for current year out-of-pocket medical expenses.

However, the critical factor in optimizing your FSA is ensuring your contributions closely match your expected healthcare costs for the year. This alignment helps you maximize your pre-tax benefits without leaving any funds unspent due to the “use it or lose it” rule.

How much do I contribute?

• Evaluate Past Expenses: Start by reviewing your medical costs from the previous year as a baseline.
• Anticipate Upcoming Needs: Factor in any expected changes, such as planned surgeries, new prescriptions, or vision care needs.
• Stay Conservative: While it’s essential to maximize pre-tax benefits, it’s also crucial not to over-contribute and risk losing unused funds. Aim to be as accurate as possible in your estimations.

6. Consider Deducting Health and Medical Expenses

Deducting health and medical expenses is an option that allows you to reduce your taxable income based on the medical costs you’ve incurred throughout the year.

What’s the Benefit?

By itemizing and deducting these expenses, you can potentially lower your overall tax bill. Specifically, you can deduct the amount of your medical expenses that surpass 7.5% of your Adjusted Gross Income (AGI).

This can be especially valuable for those with significant medical costs, offering a way to offset some of the financial burden.

Do I Qualify?

With the recent enhancements to the standard deductions, many taxpayers find that itemizing—where you’d include medical deductions—is less beneficial.

Most opt for the standard deduction because it’s higher than their total itemizable deductions.

7. Understand The Retirement Savings Contributions Credit (Saver’s Credit)

The Saver’s Credit is a tax break tailored for those with lower to moderate incomes, nudging them to make retirement contributions. Your adjusted gross income (AGI) and how you file determine the credit percentage based on your retirement account contributions.

Think of the Saver’s Credit as a two-for-one deal for those who qualify. Not only do you receive the inherent tax perks of adding to retirement accounts, but you’re also rewarded with an additional tax credit for making those contributions.

What’s the Benefit?

The credit is a percentage (ranging from 10% to 50%) of the contributor’s qualified retirement savings contributions, with a maximum credit amount of up to $1,000 ($2,000 if filing jointly). The exact percentage depends on the taxpayer’s AGI and filing status.

Saver’s Credit Rates and Income Limits for 2023:

How do I claim the credit?

1. Ensure you meet the eligibility criteria.
2. Make eligible contributions to a qualifying retirement account.
3. Complete Form 8880 (Credit for Qualified Retirement Savings Contributions) and attach it to your tax return.

8. Fine-Tune Your Tax Withholdings with an Updated W-4

Tax planning isn’t just about maximizing credits and deductions. It’s also about ensuring that the right amount is withheld from your paycheck throughout the year.

Overpaying means giving an interest-free loan to the government, while underpaying can lead to unexpected tax bills and potential penalties.

What is a W-4?

The W-4 form tells your employer how much federal income tax to withhold from your pay. Situations such as getting married, having a child, buying a house, or experiencing significant financial changes warrant a review of this form.

Whats the Benefit?

• Avoid Surprises: By aligning your withholdings with your actual tax liability, you can prevent unexpected tax bills at year-end.
• Maximize Cash Flow: If you’re consistently getting large refunds, adjusting your W-4 might mean more money in your paycheck now, which could be put to work elsewhere in your budget or investment strategy.

How do I adjust my W-4?

1. Evaluate Your Current Withholdings: Review your recent pay stub to see how much is being withheld for federal income taxes.
2. Consider Your Tax Situation: Think about the changes in your life or financial strategy that could impact your tax liabilities.
3. Fill Out the Form: Using the IRS’s online Tax Withholding Estimator can simplify this process. After entering your information, the tool will recommend a suitable withholding amount.
4. Submit the Updated Form: Once you’ve completed your W-4, give it to your employer’s HR or payroll department.

Read More: Gross Income vs Net Income

9. Give to Charity and Get Tax Benefits

Charitable giving is a wonderful way to support causes close to your heart while also reaping tax benefits.

Charitable contributions refer to donations given to qualified charitable organizations. When you make a donation, and you itemize deductions on your tax return, you can claim your contribution as a tax deduction.

Contributions can be in the form of:

• money
• goods
• stocks
• real estate
• other assets

What’s the Benefit?

The value of your donation can be deducted from your total income, which might put you in a lower tax bracket or reduce the amount of tax you owe. The maximum deduction is typically 60% of your adjusted gross income, but this can vary depending on the type of donation and the organization.

Things to Note:

• Always ensure the organization you’re donating to is a qualified charitable organization recognized by the IRS.
• Maintain a record of all donations, including receipts or written acknowledgments, especially for contributions over $250.
• Donations of property or goods have specific guidelines on how they should be valued for deduction purposes.

10. Consider Municipal Bonds for Your Portfolio

For investors in the highest tax brackets, finding ways to maximize returns and minimize taxable income becomes paramount. One such strategy worth exploring is the investment in municipal bonds.

Municipal bonds, or “munis,” are loans you give to local governments to help fund public projects like schools or roads. In return, they promise to pay you back with interest.

What’s the Benefit?

Municipal bonds can give you interest income that’s usually free from federal taxes. If the bond is from your home state, you might avoid state and local taxes too. This “tax-free” income can be especially valuable for people in higher tax brackets.

Things to Note:

• Risk: Munis are low-risk but not risk-free. The issuer’s creditworthiness matters, as some places have higher default risks.
• Interest Rates: Municipal bond prices can fluctuate with interest rates. When rates go up, bond prices generally go down, and the opposite is true.
• Taxes: Some munis might fall under the Alternative Minimum Tax, which could lessen their tax advantages for specific investors.
• Liquidity: Not all municipal bonds are easy to sell quickly without impacting their value. Keep this in mind if you might need your money soon.

Read More: 51 Top Investment Opportunities in 2023

11. Sell Losing Investments for Tax-Loss Harvesting

For investors with taxable investment accounts, tax-loss harvesting is a method that involves selling securities at a loss to offset capital gains from other investments. By effectively harnessing this strategy, you can manage your portfolio in a way that minimizes your tax liabilities.

What’s the Benefit?

This tactic not only reduces your taxable income for the year but also can strategically rebalance your portfolio. Specifically, by realizing losses, you can counteract capital gains from other investments. This becomes especially valuable in volatile markets where you can turn market downturns to your tax advantage.

Do I Qualify?

Tax-loss harvesting is primarily applicable to taxable investment accounts and isn’t relevant for tax-advantaged accounts like IRAs or 401(k)s.

Most investors can benefit from this strategy, but it requires careful planning and an understanding of your overall investment landscape.

12. Consider the Benefits of Strategic Asset Location

Strategic asset location is an advanced investment strategy that involves placing investments in the most tax-efficient accounts available to an investor.

What’s the Benefit?

Primarily, the potential for increased after-tax returns on investments. By optimally placing assets that yield different types of income in the appropriate accounts, you can maximize tax efficiency. For example:

• Holding assets that generate regular taxable income, like bonds, in tax-deferred accounts (like IRAs).
• Placing assets that yield more tax-favored income, like qualified dividends from stocks, in taxable accounts.

Does this apply to me?

The applicability of strategic asset location is broad:

• Investors with a mix of taxable, tax-deferred, and tax-free accounts (like a Roth IRA) stand to gain the most.
• Risk tolerance and investment horizon will impact which assets are best suited for which accounts. For instance, a younger investor might have a more significant stock allocation and would need to think differently about asset location than someone nearing retirement.
• Regularly reviewing and rebalancing portfolios is essential. As market conditions change and as assets grow in value or provide returns, you’ll need to adjust your strategy.

13. Explore the Potential of Opportunity Zones

Introduced by the Tax Cuts and Jobs Act, Opportunity Zones are special areas in economically-challenged communities that offer distinct tax advantages for investors. These zones aim to foster economic development and job creation in low-income areas.

Benefits at a Glance:

1. Deferred Capital Gains: Investors can defer taxes by reinvesting into specific funds.
2. Reduced Capital Gains Tax: Holding investments for a certain duration can lead to tax reductions.
3. Future Capital Gains Benefits: Long-term investments may be exempt from certain taxes.

Investors interested in these zones should seek further information to understand the complete benefits and requirements.

14. Opt for Electric on Your Next Car Purchase

In 2023, the Electric Vehicle (EV) Tax Credit is here to promote sustainable transportation, offering incentives up to $7,500 for eco-friendly vehicle purchases.

Who is Eligible?

Individuals and businesses opting for new, qualified Electric Vehicles or Fuel Cell Vehicles.

What is the Benefit Worth?

• Up to a $7,500 credit.
• For vehicles in service until April 17, 2023: credits vary starting from $2,500 based on battery capacity.
• For vehicles post-April 17, 2023: earn between $3,750 and $7,500, contingent on specific criteria.

Read More: IRS: Credits for New Clean Vehicles

15. Mimic the Ultra-Wealthy and Buy Real Estate

For those diving into the world of real estate, there’s more to gain than just property value.

Have you ever wondered how the wealthy win the tax game? Real estate plays a pivotal role.

Key strategies to leverage:

• Bonus Depreciation: Deduct a significant chunk of the property price immediately in the year of purchase.
• Cost Segregation: Speed up depreciation by categorizing assets within your property, leading to significant short-term tax savings.
• 1031 Exchange: Perfect for reinvesting, this allows deferral of capital gains tax when transitioning from one property to another.
• Passive Activity Losses: Offset other passive income using losses from your real estate investments in some situations.
• Real Estate Professional Status: Spend a lot of time in real estate? You might qualify as a “real estate professional”, allowing you to counterbalance rental losses against other income sources.
• Mortgage Interest Deductions: Especially beneficial in the initial years of a loan, homeowners can typically deduct the interest paid on their mortgage.

Read More: 5 Ways to Finance Your Real Estate Business