8 Tips To Reduce Your Tax Bill For The Next Tax Season

It’s never too early to start thinking about tax season, no matter how far off it seems. Tax time will return before you know it, and by then it’ll be too late for many of the maneuvers that can lower your tax bill and keep more of your money in your pocket.

So don’t spend the tax offseason procrastinating—take action instead. Now is the perfect time to consider these eight moves that can make things less painful the next time you file your taxes.

1. Adjust Your Withholding

Your first step should be to make sure enough money is being withheld from your paychecks to avoid a huge tax bill—and underpayment penalties—at the next tax time.

If you owed a lot of money when you filed your last tax return, fill out a fresh Form W-4, “Employee’s Withholding Certificate.” Use the IRS tax withholding estimator to complete the form, then submit it to the payroll department where you work. Your employer will use the new W-4 to adjust the amount of taxes withheld from your paycheck for the rest of this calendar year.

If you’re self-employed, you must make your own estimated tax payments throughout the year. Get help from a tax advisor or use the worksheets included with IRS Form 1040-ES, “Estimated Tax for Individuals,” to calculate your estimated quarterly payment amount.

2. Contribute to a Retirement Account

Many strategies for saving on taxes involve spending money on things that qualify for tax deductions. Contributing to a tax-deferred retirement account is one of the few ways you can reduce your tax bill while keeping money in your own pocket—or at least in a retirement account with your name on it.

For the 2022 tax year, you can contribute up to $20,500 to an employer-sponsored 401(k) plan ($27,000 if you’re 50 or older). Don’t have a 401(k) plan at work? You can contribute up to $6,000 to a traditional IRA ($7,000 if you’re 50 or older).

You can deduct contributions to a 401(k) or a traditional IRA on your federal income tax return. Plus, the money can grow tax-free until retirement.

3. Contribute to a Health Savings Account

If you have a high-deductible health care plan, you can contribute to a health savings account. It’s a tax-advantaged savings account that lets you set aside money to pay for qualified medical expenses.

HSAs offer triple tax benefits. First, contributions to an HSA lower your taxable income. Second, you don’t have to pay taxes on any investment returns in the account. And third, as long as you use the money in the account to pay for qualified medical expenses, withdrawals are tax-free.

For 2022, you can contribute up to $3,650 to an HSA that covers only you, or $7,300 to a family plan.

If you don’t have a high-deductible health care plan, find out if your employer offers a flexible spending account. A health care FSA lets you pay for many out-of-pocket medical, dental and vision expenses using pretax dollars.

4. Donate to Charity

You may be able to take a tax write-off for your charitable contributions.

As long as you itemize deductions, you can deduct cash and noncash contributions to charitable organizations. Your deduction is limited to 50% of your adjusted gross income (AGI)—your gross income minus a few deductions and other adjustments—on your 2022 tax return.

The catch is, you must itemize in order to deduct charitable contributions, and roughly 90% of taxpayers claim the standard deduction rather than itemizing because it provides a bigger tax benefit.

One way to get over that hurdle is to “bunch” your donations into one year. For example, instead of donating $1,000 per year for the next five years to your favorite charity, you could donate $5,000 this year.

Bunched donations, combined with deductions for home mortgage interest, state and local taxes and out-of-pocket medical expenses, might help push your itemized write-offs higher than your available standard deduction.

5. Take Credit for Having a Child

Raising a child is expensive. Fortunately, two tax credits available to parents of dependent children can help offset some of those costs.

Child Tax Credit

The child tax credit is worth up to $2,000 per dependent child under age 17 at the end of 2022. This credit is phased out for high-income taxpayers, based on “modified adjusted gross income (MAGI)”—that is, adjusted gross income with some adjustments added back. If you’re a single filer with more than $200,000 MAGI or a joint filer with MAGI greater than $400,000, you can’t claim the credit.

The child tax credit is partially refundable, so if it brings the amount of tax you owe to zero, you can have up to $1,400 of the credit refunded to you.

Child and Dependent Care Credit

The child and dependent care credit helps pay for care for a dependent child under the age of 13 (or a spouse or dependents not able to care for themselves) while you work or look for work.

The size of the credit depends on the number of dependents in care, the amount you paid for care during the year and your adjusted gross income.

Taxpayers with adjusted gross income greater than $438,000 cannot claim the credit.

6. Get Credit for Paying for College

Paying for college for yourself, your spouse or a dependent? If so, the tax code offers two credits to help offset those costs.

American Opportunity Tax Credit

The American opportunity tax credit is worth up to $2,500 per student during the first four years of college. To qualify, the student must be enrolled at least half time and be pursuing a degree or other education credential.

The credit is partially refundable, so if it brings the amount you owe to zero, you can get a refund of up to $1,000.

Lifetime Learning Credit

The lifetime learning credit is worth up to $2,000 per return. It’s not refundable, but it can be used for undergraduate, graduate and professional courses, even if you’re not pursuing a degree.

Both the American opportunity tax credit and the lifetime learning credit phase out for high-income taxpayers. To claim the full credit on your 2022 tax return, your modified adjusted gross income must be $80,000 or less ($160,000 or less if married and filing a joint return).

7. Avoid Capital Gains Tax

You owe capital gains tax when you sell an asset—such as investment securities or real estate—for more than you paid for it. For example, if you buy stock for $1,000 and sell it for $2,000, you owe tax on $1,000 of capital gains.

The tax rate you’ll pay on those gains depends on how long you held the asset and your total taxable income. When you’ve held an asset for one year or less, it’s a short-term capital gain taxed at ordinary income tax rates, ranging from 10% to 37%. If you’ve kept it for more than a year, it’s a long-term capital gain taxed at more favorable long-term capital gains rates.

Capital Gains Tax Rates for 2022

There are several ways to minimize or even avoid paying capital gains taxes.

• Hold on to assets long term. Holding assets for more than one year before selling allows you to take advantage of lower capital gains rates.
• Include reinvested dividends. When you sell a security, be sure to include any reinvested dividends in its cost basis, which is the original value for tax purposes. For example, say you purchase a stock for $1,000, invest $100 of dividends, then sell it for $2,000. If you include reinvested dividends in your basis, you pay taxes on $900 of capital gains rather than $1,000.
• Donate appreciated stock. Rather than donating cash to your favorite charity, consider donating stock that has appreciated for more than a year. When you donate stock, you don’t have to pay capital gains. Plus, you can claim the stock’s fair market value as a charitable donation.

8. Take Advantage of State Tax Breaks

Many states offer their own versions of popular federal tax deductions and credits, along with tax breaks unique to that state. So don’t forget to look for ways to reduce your tax bill there.

For example, New York’s Empire State child credit is available to taxpayers who claim the federal child tax credit. California has its own child and dependent care expenses credit, worth a percentage of the federal credit. Arizona provides two separate tax credits for residents who make contributions to charitable organizations.

Tax credits and deductions vary by jurisdiction, so check with your tax advisor, state taxing authorities and any local ones to make sure you don’t miss out on tax breaks available to you.