How To Save On Taxes: 10 Strategies That Really Work

Taxes are one of the things we’re guaranteed to encounter in life. While you can’t avoid paying taxes, there are strategies you can use to reduce how much you’ll pay. This can include making contributions to a retirement account, creating a health care expense account, setting up an education fund or using tax credits.

Tax Credits And Tax Deductions: What You Should Know

For starters, let’s define the critical difference between a tax credit and a tax deduction:

• A tax credit directly reduces the amount of money you owe in taxes. If you have a $1,000 tax credit, your tax liability is reduced by $1,000.
• A tax deduction reduces your taxable income, which indirectly lowers your overall tax liability. The value of a tax deduction depends on your tax bracket, so a $1,000 deduction might result in a smaller reduction in taxes owed.

When you’re filling out your taxes, you’ll run across the term “standard deduction.” This is a predetermined amount set by the government that you can subtract from your taxable income to reduce your overall tax liability without needing to itemize specific deductions.

For some people, it can make sense to just file your taxes using the standard deduction — criteria include the total value of your potential itemized deductions, such as mortgage interest, state and local taxes, and charitable contributions. If the amount you would deduct is less than the standard deduction, choosing this option can simplify your tax-filing process and reduce your taxable income.

10 Tax Strategies To Keep More Of Your Money

There are many strategies to reduce taxes that are available to the average American — unfortunately, not everyone is aware of them. Here are some of the more practical ways to change your income tax bracket, which in turn reduces your tax liability.

1. Adjust Your Retirement Accounts

When you contribute to a retirement account, that money is taken from your income before you are taxed (hence the name “pretax income”). By contributing more to your retirement plan you typically decrease your taxable income, which leads to a lower tax burden. With traditional IRAs, for instance, your earnings grow tax-deferred until withdrawal, when they are taxed as ordinary income.

By contrast, a Roth IRA uses after-tax contributions, meaning you don't get an immediate tax deduction but you won’t owe taxes when you start taking distributions in retirement. Additionally, you must take a minimum distribution from a traditional IRA starting at age 72, while Roth IRAs have no such requirement, which makes them a more flexible choice for retirement planning.

2. Make Investments That Focus On Capital Gains

Another way to lower your tax liability is to make investments that provide long-term capital gains, like mutual funds, municipal bonds and real estate. These assets often qualify for lower tax rates if you hold them for over a year, avoiding short term capital gains tax and potentially resulting in significant tax savings. Additionally, long-term investments tend to provide more stable and consistent returns, allowing investors to benefit from compounding interest.

3. Consider Your Health Care

Health care accounts such as health savings accounts (HSAs) and flexible spending accounts (FSAs) can reduce your tax burden by allowing you to contribute pretax dollars toward them. HSAs offer the added benefit of tax-free withdrawals for qualified medical expenses, providing a double tax advantage. In addition, using these accounts for eligible medical costs not only reduces your current tax liability but also helps you plan for future health care expenses, contributing to long-term tax savings.

Here are some of the most common medical expenses you can cover with your accounts:

• Insurance copayments
• Insurance deductible payments
• Childbirth classes for expectant mothers
• Crutches
• Dental care, including braces, fillings, extractions and cleanings
• Eye exams
• Eye surgery
• Eyeglasses
• Hearing aids
• Flu shots
• Infertility treatments
• Inpatient drug and alcohol treatment
• Psychiatrist and psychologist visits
• Speech therapy
• Wheelchairs
• X-rays
• Vasectomies

4. See If You're Eligible For Tax Credits

As a reminder, tax credits directly reduce the amount of money you owe in taxes. Some helpful tax credits include:

• The Earned Income Tax Credit (EITC): This credit provides financial assistance to low- and moderate-income individuals and families.
• The American Opportunity Tax Credit (AOTC): This credit helps to reduce the cost of higher education for eligible students and their families by providing financial incentives for tuition, fees and course materials.
• The Child Tax Credit: This credit helps lower the overall tax liability of eligible parents or guardians for each qualifying child under the age of 17.
• The Child And Dependent Care Credit: This credit offers financial assistance to individuals who have qualifying child or dependent care expenses, with the goal of enabling them to work or actively seek employment.

5. Set Up Funds For Educational Expenses

When you set up a college savings fund like a 529 plan, you can reduce your tax burden by contributing post-tax dollars into the account while enjoying potential tax-free growth on the investments. Also, qualified withdrawals from the 529 plan for education expenses, including tuition and books, are tax free.

Establishing a 529 plan can also provide benefits for your child, as 529 plans typically allow funds to be used for a wide range of eligible education expenses.

6. Don't Overlook State Taxes

In addition to federally allowed deductions, there are state deductions and credits that can help reduce your overall tax liability. For instance, many states offer deductions for expenses such as mortgage interest, property taxes and contributions to state-sponsored college savings plans, which can lower your taxable income. State tax credits can also be available for investments in areas such as renewable energy, historic preservation or even for those who pay for child care. These state-level deductions and credits can vary widely between states, and you can find your specific state's tax laws on this official U.S. government page.

7. Get Deductions For Charitable Contributions

You can claim some deductions on your taxable income when you make charitable donations, which can lower your tax burden. It's important to note, however, that only cash or non-cash gifts (such as goods or securities) are typically eligible for deductions, and donated labor or services generally do not qualify as deductible charitable donations. For that reason, it’s critical to keep accurate records to ensure your contributions meet IRS guidelines.

8. Adjust Your Withholding

Completing a new W-4 form allows you to fine-tune your tax withholding and have more — or less — money withheld from your paychecks to align with your actual tax liability. When you increase allowances or exemptions on your W-4, for instance, a smaller amount of money will be withheld from each paycheck, resulting in a higher amount of cash paid out in your paycheck. Before making changes, it may be a good idea to contact a tax professional.

9. Sell Underperforming Stocks

Selling underperforming stocks at a loss — commonly known as “tax-loss harvesting” — could change your taxpayer's tax bracket by offsetting capital gains and reducing your taxable income. When your capital losses exceed capital gains, for instance, you can deduct up to $3,000 in capital losses against other sources of income.

It's important to note, however, that buying the same stock within 30 days after selling it for a loss can trigger the IRS's "wash-sale" rule, which disallows the loss deduction.

10. Talk To A Financial Advisor Or Tax Professional

Clearly, taxes are a complicated issue. To save as much money as possible, contact a financial planning professional or tax preparer to find legal, ethical ways to reduce your tax burden.

FAQs About Saving On Taxes

Questions can often arise when looking for ways to save money on your taxes.

Is it better to claim 1 or 0 on your taxes?

Whether it's better to claim 1 or 0 on your taxes depends on your individual financial situation. Claiming zero allowances means you'll have more taxes withheld from your paycheck, potentially leading to a larger refund at tax time. Claiming one allowance results in less withholding and a slightly higher paycheck, but it may lead to a smaller refund or a tax bill if you underpay during the year.

How can I reduce my taxes if I make over $100,000?

Reducing your taxes when you earn more than $100,000 often involves a combination of strategies — one approach is to maximize contributions to tax-advantaged retirement accounts such as a 401(k) or an IRA, which lowers your taxable income. Additionally, you should consider taking advantage of tax credits, deductions, and exemptions, such as the Child Tax Credit, mortgage interest deduction or itemized deductions (if they exceed the standard deduction). Lastly, it’s always helpful to consult with a tax professional to explore investment strategies, charitable contributions and other financial moves that can help reduce your tax burden.

How do I change the amount of taxes withheld from my paycheck?

To adjust the amount of taxes withheld from your paycheck, you need to update your W-4 form with your employer and increase — or decrease — the number of allowances you claim. By claiming fewer allowances, more taxes will be withheld from each paycheck, while claiming more allowances will reduce the amount withheld and give you higher take-home pay.

The Bottom Line: Reduce Your Taxable Income To Pay Less

Taxes may be inevitable, but there are ways to reduce your tax burden, ranging from selling underperforming stocks to putting more money into retirement accounts to adjusting your W4 withholdings. Another critical way you can improve your financial situation is to know where your money is going — download the Rocket Money℠ app to help lower your spending, track your net worth and much more!