How to save income from taxes

Income is taxed at the federal, state, and local levels, and earned income is subject to additional levies to fund Social Security and Medicare, to name a few. Taxes are difficult to avoid, but there are many strategies to help ward them off. Here are six ways to protect your income from taxes.

1. Invest in Government Bonds: Buying a government bond essentially means lending money to a state or local governmental entity for a set number of interest payments over a predetermined period. Once the bond reaches its maturity date, the full amount of the original investment is repaid to the buyer.

Interest on government bonds is exempt from federal taxes, and may be tax exempt at the state and local level as well, depending on where you live. Tax-free interest payments make municipal bonds attractive to investors.

However, government typically pay lower interest rates. Because of the tax benefits, government bonds’ tax equivalent yield makes them attractive to some investors. The higher your tax bracket, the higher your tax equivalent yield.

2. Go for Long-Term Capital Gains: Investing can be an important tool in growing wealth. An additional benefit from investing in stocks, mutual funds, bonds, and real estate is the favorable tax treatment for long-term capital gains.

An investor holding a capital asset for longer than one year enjoys a preferential tax rate of 0%, 15%, or 20% on the capital gain, depending on the investor’s income level. If the asset is held for less than a year before selling, the capital gain is taxed at ordinary income rates. Understanding long-term versus short-term capital gains rates is important for growing wealth.

For 2021, the zero rate bracket for long-term capital gains applies to taxable income up to $80,800 for married couples and $40,400 for single individuals.3 A tax planner and investment advisor can help determine when and how to sell appreciated or depreciated securities to minimize gains and maximize losses.

3. Start a Business: In addition to creating additional income, a side business offers many tax advantages. When used in the course of daily business, many expenses can be deducted from income, reducing the total tax obligation. Especially important tax deductions for self-employed individuals are health insurance premiums which are available if special requirements are met.

Also, by strictly following Internal Revenue Service (IRS) guidelines, a business owner may deduct part of their home expenses with the home office deduction. The portion of utilities and Internet used in the business may also be deducted from income. 

4. Max Out Retirement Accounts and Employee Benefits: In both 2020 and 2021, taxable income can be reduced for contributions up to $19,500 to a 401(k)  or 403(b) plan. Those 50 or older can add $6,500 to the basic workplace retirement plan contribution. For example, an employee earning $100,000 in 2020 or 2021 who contributes $19,500 to a 401(k) reduces taxable income to only $80,500.

Those who don’t have a retirement plan at work can get a tax break by contributing up to $6,000 ($7,000 for those 50 and older) to a traditional individual retirement account (IRA) in 2020 and 2021. Taxpayers who do have workplace retirement plans (or whose spouses do) may be able to deduct some or all of their traditional IRA contribution from taxable income, depending on their income.

The deduction is phased out for adjusted gross incomes at different levels, higher in 2021 than in 2020, depending on whether claimed by on a single taxpayer’s return, joint return, married individual filing separately as well as taking into account any participation by a taxpayer in another plan.

5. Claim Tax Credits: There are many IRS tax credits that reduce taxes, such as the Earned Income Tax Credit. For 2020, a low-income taxpayer could claim credits up to $6,660 with three or more qualifying children, $5,920 with two, $3,584 with one, and $538, if none.

For 2021 only, the size of the earned-income tax credit will increase for childless households. The maximum credit amount for childless people increases to $1,502, from $543. The age range has also been expanded. People without children will be able to claim the credit beginning at age 19, instead of 25, with the exception of certain full-time students (students between 19 and 24 with at least half a full-time course load are ineligible).

The American Opportunity Tax Credit offers a maximum of $2,500 per year for eligible students for the first four years of higher education and the Lifetime Learning Credit allows a maximum 20% credit for up to $10,000 of qualified expenses, or $2,000 per return.

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(Article sources from : https://www.investopedia.com/articles/personal-finance/032116/top-6-strategies-protect-your-income-taxes.asp)