Taxes are one of the few certainties in life. How much you pay in taxes is in your control.
You want to be able to balance paying your share, but legally minimizing the amount you pay in taxes. One of the ways you can do that is to pay income taxes in a lower tax bracket. The problem most people have is that they don’t know all of the tax brackets.
Do you want to know more about making your tax bill smaller?
Read on to learn about the different tax brackets and how to lower your tax bracket and get a lower tax bill
Tax Brackets and Income Taxes
In America, we tax citizens based on a progressive tax system. That means that the more money you earn, the more you’ll pay in taxes. There are 7 tax brackets in the US tax code, and to make it more complicated, the tax brackets vary by filing status.
You can see the 2020 tax brackets that the IRS recently published. This determines the percentage you’ll pay in federal income taxes on your earnings.
If you are single and you earn more than $9,875 in 2020, you’ll pay 10% on that first $9,875. You’ll then pay 12% in income taxes on anything up to $40,125. Anything over $40,125 will put you in the 22% tax bracket.
Adjusted Gross Income and Your Taxes
The IRS calculates your taxes not on your gross or net earnings. Your adjusted gross income is the gross earnings for the year, subtracted by your deductions.
The deductions are the key to lowering your tax bracket. These are incentives that are written into the tax code to drive certain behaviors.
For example, the American Dream used to be buying a home. The tax code gives a ton of deductions to incentivize potential home buyers into taking the leap into homeownership.
Here’s how your adjusted gross income works. You earned $80,000 last year and you are filing as a single person. You would be in the 22% income tax bracket. Without the adjusted gross income, you’d pay $13,390 in income taxes.
If you have $20,000 in deductions, your adjusted gross income becomes $60,000. You’d pay $8,990 in federal income taxes.
How to Lower Your Tax Bracket
Now that you know about the different tax brackets and how they impact your tax bill, it helps to know that you can lower your tax bracket. Lowing your tax bracket is the reason why you hear about so many millionaires paying so little in taxes.
There are other reasons, too, but getting into a lower income tax bracket certainly helps. You can do the same by knowing what deductions you can take to lower your tax obligations.
1. Pay State and Local Taxes
There was a big controversy in the Tax Cuts and Jobs Act, which was the reduction of the SALT tax deduction. This allows you to deduct the amount you pay in state and local taxes, like property taxes.
This could amount to massive savings, but the bill reduced it to only $10,000 when it used to be unlimited. The House is trying to repeal the SALT tax limits this year, so keep an eye on the news to see what happens next.
2. Start a Business
There are tons of advantages if you start your own business. You can claim deductions for travel, driving to meetings, home office, business expenses, and so much more.
These deductions could lower taxes a great deal depending on the legal and tax structure of the business. In most cases, a business is a sole proprietor, so your business expenses would be listed on your personal taxes using a Schedule C form.
3. Save for the Future
Setting aside money in a 401(k) or IRA plan can be deductible up to a certain amount in 2020. In most cases, the cap is $6,000 for an IRA and $19,500 for a 401(k).
Be aware that not all plans qualify for deductions, so double-check the rules before you open an account.
4. Pay Student Loan Interest
If you paid student loans during the year, the interest up to $2,500 is deductible from your taxes. You will have to meet income limits in order to qualify for this deduction.
5. Track Your Earnings Through the Year
Tax season doesn’t happen in the first quarter of each year. You need to treat the entire year as tax season. It helps to check your income and withholdings a few times a year to make sure that you’re not paying too much or too little in taxes.
If you have a business, check your profit and loss statements each month and pay your estimated tax payments on time.
How to Handle a High Tax Bill
If you don’t take these steps to lower your tax bracket, you could end up paying much more in taxes than you anticipated. This caught many people by surprise after the Tax Cuts and Jobs Act.
They didn’t check their withholdings and either received a larger than expected bill or a smaller refund. If you owe a lot of money to the IRS, you should consider working with tax relief lawyers to review your situation and tell you your best course of action.
The IRS is usually willing to work with you on a payment plan or negotiate the amount you have to pay in some extreme circumstances. An attorney will help you figure it out to prevent bank levies or property liens.
Be Smart and Lower Your Tax Bracket
Understanding the tax code in America isn’t easy to do. There are so many hidden deductions and tax brackets, it’s very difficult to learn and understand.
Yet, this is the key to learn how to lower your tax bracket and pay less in federal income taxes. When you take all of your deductions that you’re legally entitled to, you lower your adjusted gross income. That is what is used to determine your tax bracket and how much income tax you’ll pay.
Be sure to visit the Finance section of this site for more helpful tips to manage your wealth.