For many, the term “tax shelters” sounds negative, but there are many perfectly legal tax shelters. Moreover, many people assume tax shelters are available only to the rich. In fact, many of the best legal tax shelters are perfectly accessible to anyone of any income level. A tax shelter, simply put, is a method of reducing your amount of taxable income, in order to pay less in taxes.
One factor that recent changes in the law have made in reducing taxes is the doubling of the standard deduction. As of fall of 2018, the standard deduction is now twice its former number, increasing the number of people who would benefit more from itemizing their tax deductions. The best way to maximize your tax savings is to calculate your itemized deductions and compare their sum total against the standard deduction to see which one is greater. It is also worth realizing that the doubling of the standard individual deduction has not yet been made permanent. Unless it is in the future, it expires at the end of 2025. At this point, legal tax shelters and itemized deductions are even more relevant and valuable for more individuals.
Retirement Account Contributions
Retirement accounts are tax-advantaged. If your employer offers a 401(k) or 403(b), then participate and make the largest deposits are you are able to within your budget. If your employer does not offer such a plan, then you can still open an IRA, either a Traditional or Roth. Even if you are self-employed, you can still take advantage of the tax benefits of retirement accounts through opening either a SEP-IRA or a solo 401(k).
All of these programs shelter taxes differently, but the gist is the same: either deposits are tax-deferred or withdrawals are tax-exempt. In other words, either you deposit taxed funds and the withdrawals you take are untaxed or you deposit untaxed funds and taxes are only paid on withdrawals. Figure out which options are available, determine which strategy among those options is best, and start funding your retirement account.
Workplace Benefits
If you get health insurance or other benefits through your employer, then they are likely paid for by deductions from your paycheck. These deductions are taken before taxes, meaning you are not taxed on any income applied to the premiums for those benefits. Take advantage of all the benefits your workplace offers to lower your tax burden and enjoy health care to improve your quality of life.
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Similarly, some employers reimburse their workers for expenses like education or even provide a car allowance. These reimbursements are also untaxed, in essence sheltering those earnings from income taxes you spend on reimbursable uses.
Medical Savings Accounts
A Medical Savings Account, also known as a Health Savings Account (HSA), is a type of Flexible Spending Account (FSA) offered by some employers to aid workers in managing their health care and medical costs. Both the employer and worker can make tax-free contributions to these accounts, the only restriction being those funds must be spent on eligible medical expenses.
Some such accounts have rules you must be careful to follow, such as spending their balances by a deadline. If your health plan has a high deductible whether you obtained it on your own or through an employer, then you qualify to open an HSA. Unused funds in an HSA roll over from one year to the next and, after you turn 65 years of age, can be treated like a retirement account. If your medical expenses or health care costs are high, then HSAs are one way to shelter significant taxes on those expenses.
College Savings Accounts
Like HSAs help you save on taxes for medical and health care expenses, College Savings Accounts (CSA) help you save on taxes for educational expenses. A 529 savings plan is a type of account into which you deposit taxed income and from which withdrawals are tax-free.
Many 529 savings plans have fees though, so be sure your tax savings exceed what you pay in fees. Otherwise, the plan might cost you more than not having one at all. Be aware, having a 529 plan may influence your or your child’s eligibility to receive financial aid.
Municipal Bonds
Income earned from investing in municipal bonds is not taxed on a federal level. Depending on where you live, your municipal bond income may not be charged state taxes either. However, the catch with this option is that these tax savings are usually factored into the determination of what size of return to provide bondholders.
Own Your Home
If you own your home rather than rent, then you can save considerable taxes on your housing costs. There are tax savings for homeowners the year you purchase your home, every year thereafter and upon the sale of the home. Common tax deductions for homeowners are property taxes and mortgage interest.
You can also deduct some of the interest you pay on a home equity loan or line of credit taken out against the property. If, when you sell your home, you have lived there for two years minimum of the previous five before the sale, then you do not have to pay taxes on $250,000 of your capital gains from the sale, for single individuals, and $500,000, for married couples filing their taxes jointly.
Open Your Own Business
Business owners can benefit from an array of tax deductions on qualifying business expenses. If you invest your own money in your business for any of these purposes with the intention of earning a profit, then those expenses count as tax savings for you. You can deduct the costs of a computer, phone and software for your business from your tax burden. Be sure to track your spending on business-related expenses.
If your business operates from a home office in a place you rent or own, then you can deduct a portion of the household expenses for that home from your taxes based on how much of the home’s square footage you use for the business. Examples of tax-deductible home business expenses include utilities, maintenance and insurance costs.
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