With less than three months left in the year, the tax season is coming to an end. As with corporations, tax for U.S. individuals is not calculated based on total income, but rather certain items are deducted from it. There is still time to reduce your tax liability, but this article is also aimed at those who are already thinking about the next tax year.
Tax Year Basics
Before we get into the details of the tax reduction, it’s worth clarifying a few things about the US tax year (for example, when does tax season start). In most countries around the world, the assessment period for income tax and other taxes affecting individuals is based on the calendar year. In the US, the tax season 2021 start date was on January 01, and it’s not intended to change in the future. Tax season 2021 ends on December 31st.
Many people get it wrong by not approaching the issue of taxation with the right mindset. Taxable income is calculated as the difference between income and deductible expenses, however, many individuals do not take the opportunity to spend part of their income on themselves.
Future Savings — present Tax Deductions
Adding to your retirement account, even at the end of the year (in one lump sum), reduces your tax base, so you can hit two birds with one stone: First, you can achieve a lower tax bracket, and second, you can save for your retirement. So it pays to participate in company 401(k) plans or maintain your own plan as a business owner. No matter how old you are, you can contribute to an IRA up to $6,000 ($7,000 if you’re 50 or older) if you do not participate in a workplace retirement plan.
There are multiple options if you want to deduct your taxes in a way that also benefits your future:
- A Health Savings Account offers 3 advantages: You pay no federal income tax, state or local taxes, or FICA taxes on the money you deposit, the balance grows tax-deferred and can be invested later, and withdrawals are tax-free if used for medical expenses.
- Flexible Savings Account: FSAs can also be used to set aside money pre-tax to cover qualified medical expenses like deductibles, as long as the plan is employer-sponsored.
There are a few last-minute solutions if you want to lower your personal taxes:
- A special charity contribution can deduct up to $300 per person or up to $600 for married couples along with the standard deduction.
- If you are itemizing deductions, consider donating appreciated property as well. This could save you on capital gains tax down the road.
The Best Advice — Plan in Advance
The above points can go a long way in lowering our taxes, however, as the end of the year approaches, it is harder to work true miracles to increase the tax deduction. For this reason, we strongly recommend that you plan next year well in advance to avoid lump sum payments at the end of the year and have a more predictable tax season.