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What Are Some Ways to Minimize Tax Liability?

Few of us want to pay more tax than we have to. Understanding the tax credits and deductions that we’re eligible for, and calculating them correctly, can mean the difference between owing more money at tax time or receiving a welcome refund. Here are three simple ways to minimize your tax liability.

Key Takeaways

  • The key to minimizing your tax liability is reducing the amount of your gross income that is subject to taxes.
  • Putting pre-tax dollars into a retirement plan like a 401(k) is one easy way to reduce your taxable income for the year.
  • If you sell an investment that has lost value, you can use that loss to offset other income.

Increase Retirement Contributions

Employer plans, such as a 401(k) or a 403(b), allow you to contribute pre-tax dollars to your account, up to a certain maximum. For 2020, the maximum is $19,500 (up from $19,000 for 2019). Anyone over the age of 50 can kick in an additional $6,500 as a catch-up contribution, for a total of $26,000. Contributions to traditional 401(k) or 403(b) plans are made through regular paycheck withholding and offer a direct dollar-for-dollar reduction to total taxable income. (Another version of these plans, the Roth 401(k) or Roth 403(b), doesn’t provide any upfront tax benefit but does allow for tax-free withdrawals later on.)

If an employer-sponsored plan isn’t available to you, consider a traditional IRA instead. Your contributions will be made with pre-tax dollars, resulting in a direct reduction to your taxable income for the year and ultimately to your total tax liability. For 2020, your contributions cannot exceed $6,000, with an additional $1,000 allowed for those age 50 and above. (As with 401(k) and 403(b) plans, there is also a Roth IRA, without any immediate tax benefit.)

Profit From Investment Losses

Selling off investments that have declined in value since you purchased them can also help you reduce your tax liability for the year—a strategy often referred to as tax loss harvesting. These investment losses can be written off against your investment gains or other income up to a certain limit each year, currently $3,000. What’s more, any amount you can’t use this year can be carried forward to future years, reducing your taxes then, as well. Conversely, it can be beneficial to delay selling an appreciated asset and avoid being taxed on your gain, especially in a year when your taxable income is already high.

The charitable contributions you make during the year can reduce your taxes—but only if you itemize deductions.

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