How to (very legally!) Minimize Your Tax Bill
Filing our taxes can be an arduous process that we often try to get through as quickly as possible. But before we hit submit or give our accountants the final okay, we want to make sure we are minimizing our tax bill (or maximizing our tax return).
Why? First and foremost, that means we’ll have more money in our pockets to allocate towards our goals. And second, if we don’t, we’re paying more taxes than we need to.
Here are some ways to minimize your tax bill or increase your tax refund. If it’s too late to utilize some of these strategies, you can plan ahead to maximize them next year.
Max out your IRA.
Many of us don’t realize that we actually have until the filing deadline, April 15th, to max out our IRAs for the previous year. You have until April 15, 2025 to max out your 2020 IRA contributions. Yay! There’s still time.
Contributions to a Traditional IRA (where the money goes in pre-tax) can reduce your taxable income. Contributions to a Roth IRA won’t give you a deduction, but you may qualify for the Saver’s Credit (more on this below).
The contribution limit for an IRA in 2024 and 2025 is $7,000 - or $8,000 if you are over 50 years old.
What exactly is a tax deduction?
We pay taxes on our taxable income, not our total income. A tax deduction decreases our taxable income. For example, a $1K tax deduction reduces our taxable income by $1K. Let’s say we earn $65K. With a $1K deduction, we’d now be taxed on $64K.
If your effective tax rate is 30%, then a $1K tax deduction saves you $300 ($1K x 30%). This will either result in you paying $300 less in taxes or receiving $300 more in your tax return.
Max out your HSA.
Pre-tax contributions to a Health Savings Account (HSA) can also reduce your taxable income (which means less in taxes or a higher tax return). The contribution deadline is also the tax filing deadline - April 15th.
There are some other great benefits to having an HSA as well, like tax-free investment growth.
To qualify for an HSA you need to have a high deductible health plan (HDHP), meaning your deductible is $1,600 for an individual or $3,200 for a family in 2024.
Contribute to an employer sponsored FSA.
For those who have a Flexible Spending Account (FSA) available through work, you can contribute to reduce your taxable income because contributions are pulled from pre-tax dollars.
You can use the money you contribute for qualified medical expenses. There are also Dependent Care FSAs you can use for child or other dependent care expenses.
The caveat is that the money is a'use-it-or-lose-it'. Some plans allow you to roll over up to $660 (in 2025) to the next year and / or have an extended deadline, but otherwise, any amount that goes unused disappears.
Know and use your tax deductions.
You can take each of the following deductions without itemizing your taxes (more on what itemizing means in the next section). The limits will change year to year, so give them a quick google.
401(k) contributions
Traditional IRA contributions
HSA/FSA contributions
529 contributions
Student loan interest
The next group of tax deductions fall into a different category. You can take the standard deduction (a fixed amount you get based on your filing status) or you can itemize. Most of the time people take the standard deduction.
“Fun” fact: For the standard deduction, you don’t have to keep receipts or records. When you qualify for more than the standard deduction (in 2024 it’s $4,600 if you’re single; $29,200 if you’re married filing jointly), you’ll itemize your deduction (so you can pay less in taxes). Itemizing means actually breaking out what you spent on deductions like medical bills or charitable contributions.
Here are some common itemized deductions:
Medical or dental expenses
Mortgage interest
Charitable donations
Home office expenses
State income and property taxes
Casualty, disaster, and theft losses
What’s adjusted gross income?
Let’s start with our gross income. Our gross income is the total amount we earned through our salary, interest, rental income, business profit, and any other wages. It’s the total of what we earned in a given year before we paid for taxes and other expenses.
To calculate our adjusted gross income (AGI), we take our gross income and adjust it for certain deductions. Our AGI is what we’ll use when filing our taxes and will determine if we qualify for certain deductions and credits.
Be strategic with timing
To maximize deductions in one year, you can plan to make deductible purchases before year-end. For example, you can pay January’s mortgage payment before December 31st to deduct more mortgage interest.
If you haven’t spent the funds in your child or dependent care FSA, you can prepay expenses where possible. You can contribute to more charitable organizations if you itemize your deduction (or plan to that year) or even make purchases for your business if you’re self-employed or have a side hustle.
When it comes to certain expenses, specifically business related expenses, there’s a popular belief that expenses that are tax deductible are free. That’s sadly not the case. If I wasn’t going to buy a new printer for my home office anyway, I won’t be saving money if I buy one to reduce my taxable income. It can be helpful to think about these expenses as items we get on sale (or for a discount in the same amount as our tax rate).
Understand potential tax credits.
Tax credits are the holy grail of tax benefits because they take money off your tax bill dollar for dollar. If you owe $1,000 in taxes and receive a tax credit for $250, you now owe $750 in taxes. If you’ve overpaid, you get a return.
There are refundable and nonrefundable tax credits. With refundable credits if the credit is larger than the taxes you owe, you can get a refund. If you owe $500 in taxes and qualify for a $700 refundable tax credit, you should receive a $200 refund.
A nonrefundable tax credit can only reduce your tax bill to $0, nothing more. If you owe $500 in taxes and qualify for a $700 nonrefundable tax credit, you will owe $0 in taxes.
There are many options for credits. Here are some of the common ones.
Make sure you’re choosing the most beneficial filing status.
Choosing your filing status can affect how much you pay in taxes and what kind of return you get. If you’re married, your choice is to file jointly or separately (married, filing separately).
There are many factors to consider, including income, deductions, and tax credits. The simplest way to decide whether to file a joint return or separately is by preparing your taxes both ways and choosing the filing status that generates the most favorable outcome.
If you’re single and have a dependent (like a child or parent), you can choose to file as Head of Household, which often comes with tax benefits.