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How to Save Money on Taxes: 4 Tricks

by Nick Gallo

Everyone wants to know how to save money on taxes. After all, losing a chunk of each paycheck feels like someone taking a bite out of your lunch. Those sandwiches will just never taste as good.

Fortunately, there are some simple and accessible ways that you can reduce your tax bill significantly. These four strategies will help you shield large portions of your earnings, delay paying some of your taxes indefinitely, and put thousands of dollars more into your pocket each year.

1. Fund Your Tax-Advantaged Accounts

Tax-advantaged accounts are by far the easiest ways to save on taxes for individuals. There are a dozen options available, but the most important ones are:

  • 401(k)s
  • Individual Retirement Accounts (IRAs) 
  • Health Savings Accounts (HSAs)
  • 529 Plans

Tax-advantaged accounts reduce your taxable income (upon contribution or withdrawal) and allow your savings to grow tax-free until you need them.

For example, if you made $75,000 working as a W-2 employee in 2019, you would have owed the IRS $15,412. But if you were able to fully fund your traditional 401(k) plan, you would reduce your tax liability for the year to just $11,452. That’s an immediate savings of $3,960!

Check out the chart below for a summary of the contribution, deduction, and withdrawal rules for each major type of account in 2020:

tax advantaged accounts

2. Start a Side Hustle

Earning extra cash on the side has become mainstream. The gig economy is booming, and over 50% of the US workforce will be participating in it by 2027.

gig economy growth
Source: Mastercard Newsroom

But side hustles aren’t just a source of extra income, they’re also a great way to save on taxes using strategies that are inaccessible to regular employees.

Your side hustle is a business to the IRS, and you’re both the employer and employee (even if it’s a solo operation). As a result, you have access to these three extra tools:

  • Business deductions: Wage-earners aren’t allowed to deduct any expenses incurred while working, since the employer reimburses them and gets the deduction. But when you have a side hustle, you are the employer and get to deduct all ordinary and necessary expenses related to your business like travel, equipment, and even home office costs.
  • Solo 401(k)s: Self-employed individuals have access to a special version of the 401(k). Solo 401(k)s function similarly to the regular version, but allow you to contribute as both employer and employee. Your employee portion is still limited to $19,500, but your employer portion can be as much as 25% of your net self-employment income as long as your total combined contribution doesn’t exceed $57,000.
  • Business entities: You can organize your business using several legal structures, but the S-corporation is often best for small businesses. Self-employed individuals usually have to pay twice as much as employees in payroll taxes since they’re responsible for the employer and employee portions. But with an S-corp, you can take a reasonable salary from the business (which is also deductible) and only owe payroll taxes on that salary.

3. Take Advantage of Real Estate

Real estate has always been recognized as a powerful investment vehicle, but its ability to lower your tax bill is often underappreciated.

Some deductions are only available to real estate investors, but there are still great ways to save money on taxes if your property is your personal dwelling.

  • Mortgage Interest: The interest portion of your monthly mortgage payment is an allowable itemized deduction for the first $750,000 to $1,000,000 of debt (depending on when you bought your home). If you have a large mortgage balance or other itemized deductions that exceed the standard deduction, this is a great way to save money on taxes each year that your mortgage is outstanding.
  • Capital Gain Exemption: Whenever you sell something for a profit, you’re taxed on your capital gains, which is the excess of your proceeds over your basis (purchase price minus any depreciation). When you sell a house, this can be a pretty big tax bill. But if you’ve lived in that house for at least two out of the five years before the sale, you can exclude $250,000 of capital gains from your income ($500,000 if you’re married).
  • 14 Days of Tax-Free Rent: Rental income is usually taxable like any other source of earned income, but there is an exception: If you rent out your room or property for 14 days or less annually, you don’t even have to report the income to the IRS. If you’re someone who likes to travel, this is the perfect way to take advantage of your empty house for a couple of weeks out of the year while you’re away.

4. Use Tax-Loss Harvesting

Last but not least, we have tax-loss harvesting. If you’ve built up an investment portfolio, it’s a powerful way to save money on your taxes each year.

When you purchase assets like stocks, bonds, or index funds, some of your investments will inevitably perform better than others. Tax-loss harvesting is the process of selling off the ones that perform poorly and using those losses to offset any capital gains. 

tax loss harvesting
Source: Morgan Stanley

And even if you’re not planning to realize any capital gains during the year, you can still use those losses to offset up to $3,000 of earned income.

You can then take those funds and immediately use them to purchase something that will perform better. The new asset will just have to be different from the one you sold to qualify for the deduction and avoid a wash sale.

How Did We Do?

We hope this article has shown you some new ways to save money on taxes.

Are you going to give any of these strategies a try this year? Maybe there are other ways to save that you’d like to share with the community?

Let us know in the comments below!

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