One of our largest expenses each year is the amount we pay in taxes. Although we should all contribute to various government programs and priorities, it behooves us not to pay more than we need to. Here are some tax tips to keep in mind:
1. Contributions to retirement accounts lower your taxes. As a young professional, you have many uses for your money. Perhaps you want to go on vacation, drive a nice car, or maybe just need to keep up with rising housing costs. Regardless of the expense, it is important that you not lose sight of the bigger picture. Many of you would like to build wealth or at least become more financially stable. One way to do that is to invest money on a consistent basis. Ironically enough, investing money through retirement accounts not only helps build your net worth, but it also helps lower your taxes. When it comes to tax lowering strategies, investing through retirement accounts is a no-brainer.
2. Remember that every dollar is not taxed the same. I’m constantly reminded of this whenever I’m contemplating a new side hustle or business partnership. The tax code is progressive. This means that lower amounts of money are taxed at lower rates than higher amounts of money. As soon as you reach certain thresholds you could jump from one tax bracket to another resulting in a higher tax bill. This is important to keep in mind as you continue to progress in your career. Chances are that you will make increasing amounts of money as you continue to work, so understanding the tax implications is vital. If someone is in the 24% tax bracket, then they will only get to keep about 76cents of each dollar they earn (and this doesn’t account for state and FICA taxes). I’m not saying earn less, but don’t forget that the more you earn, the more you will owe in taxes, so plan accordingly
3. Don’t forget to account for FICA taxes. For some reason, when I think of taxes, I think of my federal tax rate. Oftentimes I forget about another high tax: FICA taxes. FICA is the Federal Insurance Contributions Act that mandates workers contribute to Social Security and Medicare. If you are employed, then your employer deducts these taxes from your paycheck. However, if you’re self-employed or own a small business like I do, then this tax becomes a lot more noticeable. Those who own a small business or who turned their side hustle into an LLC are now responsible for paying taxes on the money they earn. In addition to paying federal and perhaps state taxes on the profits, they must also pay these FICA taxes. As a self-employed person, you have to pay the employee half of FICA taxes and the employer half of these taxes. This amounts to an extra 15% in taxes you must pay, on top of your normal federal and state taxes. You may want to consult with a tax attorney or accountant for the best strategy when your business becomes profitable.
4. If you’re single and childless, you’ll likely pay more in taxes. I’m reminded of this fact every year around tax time. Many of my friends from high school who have kids are usually excited to be getting money back from their taxes. Meanwhile, I file my taxes and just hope I don’t owe anything. Why is it that my friends are getting money back and I’m not? Could be due to a variety of reasons, but there are a couple things to note: 1) single people have higher tax rates than people who are married and file their taxes jointly and 2) people who have children get more tax credits and tax deductions than people who don’t have kids. I’m not saying get married and have kids to lower taxes. This is just some insight as to why some folks may owe more or less in taxes than others.
5. You must pay taxes on business profits. Many people are entrepreneurial and have dreams of building a business they can call their own. While there is nothing wrong with this aspiration, don’t forget about one of the responsibilities of owning a business: added taxes. As a business owner, you must pay taxes on profits you make. This means you have to keep good records of business revenue and business expenses so you can determine the business profit amount to pay taxes on. Since you don’t have to pay taxes on business expenses, be sure to keep receipts of business purchases you make. Failing to do so could result in higher taxes.
6. You may be able to write off some educational expenses. This was a pleasant surprise to me the year I graduated medical school. I was able to get a noticeable sum back on my taxes that year by accounting for my time in school. The IRS has a tax credit called the “lifetime learning credit” worth up to $2000. If you’re someone who paid for some sort of schooling in 2021, you can take advantage of this credit. Those who were still in undergrad may be eligible for a different credit that results in even more money. Simply ask your school for “From 1040” so that you can enter the necessary information to get the credit.
7. You can deduct some of your charitable donations. Many people give a portion of their earned income away. Some people do it at their church and give 10% of their income as tithes. Other people give to certain non-profits or noteworthy causes throughout the year. If you do something like this as well, keep in mind that you may be able to deduct this expense. Everyone can deduct at least $300 of charitable donations. Depending on your tax bracket and the way you file your taxes, you may be able to deduct even more.
I am not a tax lawyer or accountant. However, each year I continue working in my career and building my side business, I learn even more about ways to be more efficient with my money. This includes profitable tax strategies.
What tax strategies have you learned this year?