Taxes are a fact of life, but that doesn’t mean you should pay more taxes than you must. If you are diligent about tax preparation, understand the current tax laws, and develop a plan, there are ways to legally reduce your tax liability beyond what you owe the government! And, whether you are an employee, a freelancer, or a business owner, there are legal methods to lessen what you give to the government so that you can keep more of your income for yourself!
Know Your Tax Bracket
Understanding how income tax works is the first step in legally reducing your tax bill. In many countries, including the US and India, taxes are a progressive tax system, meaning that as you earn more money, your tax rate may be a little higher on the income you earn above a certain amount. Knowing your tax bracket may also help you plan future income strategies. For example, being only a few cents below a higher bracket will help you decide what amount to contribute to a retirement account or how much to increase your deductions so you stay in a lower bracket!
Maintain Accurate Financial Records
Making organized record-keeping is an essential step toward legal tax savings. By documenting all income, expenses, investments, gifts, and other financial information throughout the year, you give yourself every opportunity to deduct or credit—claiming an appropriate deduction, rebate, or tax credit is better than not.
If you have your own business or are an employee of someone else’s, you also have the opportunity to protect yourself in the event of an audit with legitimate record-keeping; it must be considered clean, dated, and verifiable, so start with a well-structured spreadsheet and then categorize the records correctly.
Many digital tools allow you to capture a receipt, track mileage, track expenses, and provide reports. So, get started in the first financial year and keep up with records periodically.
Claim Legitimate Deductions
Tax deductions reduce the amount of your taxable income [taxable income = total income – deductions/expenses], which reduces the total amount of tax payable. Each individual’s situation is unique, and there is no limit to what you can deduct for tax purposes since many categories can qualify as tax-allowable expenses. Tax deductions may include your expenses for running the small business, medical expenses, educational fees, and even professional training.
For example, suppose you had your own office or a part of your home where you were conducting small business (as long as you had enough square footage). In that case, you may claim a percentage of the home’s expenses: electricity, rent for the premises, and even internet usage as a deduction (you’ve got a clear dedicated workspace). In addition, you may claim your transportation costs incurred due to business, equipment purchases, or even depreciation of large purchases.
Make Use of Tax Credits
While deductions only lower your taxable income, tax credits reduce the tax owed. Tax credits provide a more immediate benefit, as they can be applied to several situations – education expenses, care of dependents, or making upgrades to your home that improve energy efficiency. The key is to find out what credit you can get and how. There will often be eligibility requirements based on income, filing status, or expense. Some are refundable tax credits, meaning it is possible to get a refund if your total tax owed is zero. Non-refundable tax credits can only reduce your taxes owed to the extent of your tax liability.
Invest in Tax-Efficient Instruments
Several types of financial products are specifically set up to promote saving, investing, and just saving for something in the future; many of these also provide tax benefits. The ability to contribute to retirement plans, health plans, or long-term saving accounts means that you can reduce your taxable income. The income earned on these accounts is usually not taxable until cash is withdrawn, and before a set period, it may even be tax-free.
These types of income-enhancing and tax-reducing products not only assist you with tax benefits but also help create future financial security. You should speak to a Financial Planner to explore the opportunity of including these products in your future goals and objectives to maximize the tax benefits.
Utilize Strategies to Time Your Income
When you can control the timing of your income and expenses, you can time in a way that provides you with the most tax benefits. For example, your income will likely be higher this year than the following year. In that case, deferring the receipt of that income or timing the deduction of an expense to occur in the prior year, thereby reducing your tax bill.
If you will be taxed at a higher tax rate in the future than at present, consider recognizing some income this year and defer some expenses. This method can be especially valuable to ambitious start-ups, independent contractors, freelancers, consultants, and/or businesses that do not work with rigid timelines.
Take Advantage of Business Tax Deductions
If you’re a business or self-employed, you have a lot of eligibility for deductions that regular tax employees do not. Deductions are available for business expenses like advertising, software subscriptions, professional fees, office rentals, and travel. Even dinner expenses, when taking a client to dinner, are generally business expenses, like clothing purchases (for work), subject to your local criteria.
Make Donations to Approved Charities
Most approved charities offer taxpayer deductions that could reduce your taxable income, plus you get to do something good for others and support a cause you believe in. Donations can be cash, gifts, or services. In many tax circumstances, you can deduct while capped at a percentage of donations based on your income.
Review Your Tax Strategy Annually
Tax laws are constantly changing. They can be impacted by policy changes in addition to and in response to budget announcements and economic reconstruction. So, because something was deductible this year, it doesn’t mean you’ll be able to deduct it from next year’s taxes; likewise, new deductions could be available that you weren’t aware of. You should review your tax strategy every year to ensure you know the most updated rules. Your taxes will also change with any significant life event, such as marriage, children, property buying, starting a business, etc.
By staying informed, keeping records, investing wisely, and taking advantage of legal deductions and credits, you can substantially reduce your tax liability – all legally. Legal tax savings improve your short-term financial situation and help build wealth over the long run! Whether you work for someone else, are self-employed, or are an investor, proactive tax planning is a beneficial financial habit that pays off year after year.
