Taxes are one of the largest expenses we face in our lives. While it’s a necessary part of living in society, there are many legal strategies to reduce your tax bill. In this blog post, I’m going to share some effective ways to keep more of what you earn. Whether you’re a seasoned taxpayer or just starting to navigate the world of taxes, there’s something here for you.
Understanding How your Income is Taxed
Let’s start with the basics. Many people believe that if they earn more, they will pay a higher tax rate on their entire income. This is a common misconception. Most countries use a progressive tax system, meaning you are taxed at different rates for different portions of your income.
For example, if you live in a country with three tax brackets—0% for the first $10,000, 20% for the next $40,000, and 40% for anything above that—earning $60,000 doesn’t mean you pay 40% on the whole amount. Instead, you pay:
- 0% on the first $10,000
- 20% on the next $40,000
- 40% on the final $10,000
This results in a total tax bill of $12,000, not $24,000. It’s crucial to understand how your country’s tax brackets work so you can make informed decisions.
DIRECT TO: Why I no Longer work overtime as a Nurse
Strategy 1: Contribute to Your Employer Sponsored Retirement Accounts (401k/403b)
One effective way to reduce your taxable income is through pension contributions. In the U.S., this is often referred to as a 401(k). When you contribute to a pension, you’re putting money away before it’s taxed.
For instance, if you earn $60,000 and decide to contribute $500 a month to your pension, that’s $6,000 a year. Your taxable income drops to $54,000, reducing your tax bill from $12,000 to $9,600.
Additionally, if your employer matches contributions, that’s essentially free money! Just remember, these funds are generally locked away until retirement, so plan accordingly.
Other accounts to lower taxable income:
- Health Savings Account
- Flexible Spending Account
BONUS STRATEGY: Fill out your W4 Forms Correctly
W4 forms are so intimidating especially if it’s your first time filling it out, so I will link this article that talks about what a W4 Form is what you need to put in there.
Sometimes, if you owe money to IRS when you file IRS, you are charged with “underpayment penalty” which automatically adds to balance due. This adds up so make sure you check with your payroll settings
Strategy 2: Choose the Right Business Structure
If you have a side hustle or run a business, consider how you’re earning your income. Operating as a business rather than an individual can significantly reduce your tax bill.
When you operate as a business, you can deduct various expenses before calculating your tax. For example, if you earn $60,000 through a side business, you can deduct costs like equipment, software, and even a portion of your home expenses.
This means you only pay tax on your net income after expenses, which can lead to substantial savings. Furthermore, corporate tax rates are often lower than personal income tax rates, allowing you to retain more of your earnings for reinvestment.
Strategy 3: Invest in Real Estate
Investing in real estate has great tax benefits. First and foremost is the depreciation from real estate shelters income from tax. For example, a $200,000 building depreciated over 27.5 years provides tax shelter of $7,272 per year. This will save you almost $2000 in taxes from depreciation of real estate.
However, there are pros and cons with owning real estate. Cue: dealing with tenants, house maintenance and repairs. So, do your homework.
If you own a house, you can also claim homeowners credit: If you make your home more energy efficient through new insulation, windows, doors, and roofs in the prior year, you may qualify for a tax credit on your federal income tax return. IRS website provides details on which cr
Final Thoughts
These three strategies are just the beginning of how you can reduce your tax bill. Future blog posts will dive deeper into topics like offshore accounts, property tax, and energy-efficient vehicles that can save you money.
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