Last Updated on December 24, 2021
Are you searching for ways to save tax? Here is an article that might help to find a solution for it.
Tax is one of the largest expense in people’s life. There is no shortage of taxpayers that are looking for ways to cut down their tax liability. At the end, no one like to pay income tax, property tax, GST, excise tax, and other taxes that leave them with a small portion of their income after deduction.
When people work hard and earn money and in the end spend half or more than half of the income on taxes, it can be frustrating.
People unknowingly pay more tax that can actually can be saved. Mostly, because people are not aware of the ways that can help to cut down tax liabilities which result in saving more money on tax bills.
There are many ways through which a person can legally cut their tax liability. When it comes to save tax and building wealth, understanding the very basic tax reduction strategies can help to save more money in the pocket.
Note– Always consult a licensed Certified Public Accountant/Financial Planner before making any financial decision. The options may vary for different people and are heavily depend upon financial position and income earned.
8 Ways to Save Tax
Following are some of the ways to save tax:
1. Health Savings Account (HSA)
Medical expenses can be a significant cost. People grow old and medical expenses can be unpredictable if health issues arise. If a person fall under a high deductible healthcare plan (HDHP), he/she might be able to contribute to a health savings account (HSA).
HSA is a tax-exempted account for citizens of the United State. Money can be stashed in HSA to save for medical expenses. Pre-tax contributions are invested to HSA and withdrawals are tax-free as long as the money is use for qualified medical expenses.
The gains from the investment are also not taxable and the funds can be invest in an index fund. So, there is no need to worry about inflation eating away savings. Especially, if the money is unused for a long period of time.
In HSAs there is no deadline to withdraw funds like in some retirement accounts. However, if the person is under 65 years of age and decide to withdraw the money for non-medical expenses, the money becomes taxable and could be subject to an additional 20% penalty.
After the age of 65 year, a penalty of 20% can be avoided but will have to pay income tax on the funds not used for medical expenses, just like an IRA. HSA income is tax-free for the rest of your life for eligible medical, dental, and vision treatment expenses.
2. Flexible Spending Account (FSA)
A flexible spending account is similar to a health savings account. It can be helpful for reducing tax liabilities by using spending account funds for qualified medical expenses. The main difference is that it must be set up by the employer similar to a 401k.
Contribution to flexible spending account (FSA) is limited to $2750 per employer in a year.
The money will be deducted directly from the paycheck and deposited into a flexible spending account. The funds in the account can be contributed by the employer, employee, or a combination of both. Example of qualified expenses in FSA include acupuncture, flu shots, hearing aids, x-rays from eligible health care, prescribed medications, diagnostic devices, and other qualified items.
To access the funds in the FSA account, a debit card can be use for the expenses or simply submit the receipts to the administrator of the account. Using a debit card is probably the easier way to go but to keep records, the receipts approved that the expenses is made in fact eligible.
The biggest downside to a flexible spending account is that if the eligible person end up having a health issue for a year and the money is not used for treatment and medical expenses. The money left in the FSA at the end of the benefit period may no longer be available.
3. Employer 401k
If the employer provide a 401k plan, this is a great opportunity to take advantage of free retirement money that would otherwise not received. Usually, 3% to 6% of the salary is contributed. The 401k plan is eligible for tax benefits under internal revenue services (IRS) regulations.
401k accounts are offered and set up by the employer. The maximum contribution limit is relatively high for those able to contribute more, up to $19,500 for those under 50 years of age, and up to $26,000 for those over 50 years of age.
The biggest advantage of a 401k is the employer match if offered. Another advantage of this type of retirement account is the tax deduction for the year that is made.
The disadvantage is that there is little control over on which investment is chosen that might possibly resulting in higher-cost funds.
Typically, 401k only offer a small selection of funds. The eligible person won’t be able to withdraw funds before the age of 59years and six months, without a 10% penalty. He/she can start withdrawing funds at the age of 72.
4. Traditional IRA
A traditional individual retirement account (IRA) is an individual account that may open via an adviser or online, and the fund deposited in the account is not tax-deductible.
These funds are often less expensive with more investment choices including index funds, individual stocks, and bonds. Individual retirement accounts offer a benefit of being able to choose investment options, where 401ks typically only offer higher-cost mutual funds which can eat away funds over time.
A tax deduction is received when contribution is made to IRA but limits are low as compare to 401k. Withdrawals cannot be made before age of 59 years and six months without a 10% penalty and just like with a 401k the withdrawing available at age of 72 regardless of whether or not there is a need for money.
In 2020, an actual contribution to the IRA by an individual cannot exceed $6000. Persons 50 years of age or older can contribute to IRA $7000 by the way of catch-up contributions.
5. Roth IRA
Roth IRAs provide same investment selections and retirement benefits as traditional IRA except there is no current-year tax deduction. That might not seem very tempting at first but as a result the earnings withdrawn during the retirement will be completely tax-free. It is a great benefit especially for those who don’t need the current year’s tax deduction.
Roth individual retirement account has a wide selection of investments to invest in. With this account, the contributions are not tax-deductible and also the earnings will go tax-free with fewer restrictions when it comes to withdrawals.
Roth IRAs are not subject to mandatory distribution at any age. If a person win a lottery or have receive a large inheritance and no longer needed the money from this account. The money can be kept unused in the account and allow it to continue growing instead of being forced to take it out.
Contribution limits are same as traditional IRAs but there is income limitations applied.
6. Coverdell ESA
The cost of study in a college can be very high. Specially, when having more than one child. Saving taxes on paying for college can be very helpful. Coverdell education savings account (ESA) allow money to grow and can be withdrawn tax-free when used for education expenses.
The contributions are not tax-deductible. So, the money will be taxed during the year in which it was earned. With a Coverdell ESA, parents can contribute up to $2000 every year for each beneficiary. Contributions can no longer be made once the kids turn 18.
When the distributions are allocated to beneficiaries, the money can be used for tuition, institution fee, books, supplies, computers, and many more. The funds can even be used for some elementary school, middle school, and high school expenses.
If the beneficiary children don’t need the money for education-related expenses. The money can be withdrawn but the gains will be taxed at an ordinary income rates and it may be subject to a 10% penalty.
7. Invest in Real Estate
Real estates and rental properties are known to provide excellent tax benefits for investors’ because the government need people to provide housing to those who are unable or unwilling to own. The cost of repairs, maintenance, up-keep utilities, and management expenses are all tax-deductible.
Travel expenses associated with the property such as gas and mileage to and from visits can be deducted. Mortgage interest is also tax-deductible and the property can be depreciate based on a twenty-seven and a half year schedule.
The internal revenue service (IRS) allows investors’ to depreciate the property because the building has its own useful life before everything would be replaced. Items such as the roof, windows, plumbing, appliances, heating, and air-conditioning systems will or may not be replaced over that timeframe.
Even though, some items will not need to be replace such as the foundation and framing provided with no major issues.
Many people prefer the tax deductions offer through investing in rental properties which are hard to match when investing in paper assets such as stocks, even when they’re purchased within tax-efficient accounts.
8. Hire a CPA
Appointing a knowledgeable certified public accountant is a good idea. Particularly, if have a complicated tax situation such as business and investment income or unusual tax deductions.
If a person only earn w2 income and have very few deductions, it might be reasonable to attempt filing own taxes but then the of risk making costly mistakes or being audited might put him/her down the road.
If to take advantage of the majority of these efficient tax strategies, then working with a professional will likely to be worth the money.
CPA are experts in their field and after require to complete a 5-year business degree and passed the CPA exam, they are continually require to gain more and more education to ensure that they fully understand the tax code.
Thus, a certified public accountant (CPA) will help not only to save tax expenses but also help in financial planning.
Everyone’s situation is different which is why it is important to take professional advice that can address the personal circumstances. It’s helpful to work with a CPA throughout the year to keep taxation planning in check so there are no surprises when tax season arrives.
FAQ related to Tax Saving
Why should I save tax?
Every bit saved on the tax liability will be the money that can be hold on to instead of paying more than the fair share. If able to save tax then that money can be used to put towards wealth creation. No one wants to pay more on tax bills than they’re legally required.
who can save tax?
Anyone can save tax, with proper knowledge on taxes and their tax scenario. One can also hire a certified public accountant (CPA) if not familiar with the tax system of the country. With proper know-how strategies can be made that will help in to save tax.
He is graduate in M.B.A Finance, and owner of the financial blog “Saifwealth.com“. He started this blog to share his knowdelge in the field of finance and to help people understand and aware about the financial world.