5 Ways to Pay the IRS Less Next April

Cassandra Hubbart, DailyFinance
Cassandra Hubbart, DailyFinance
April 15 has come and gone, and most people have put another year of tax-return preparation behind them. But a recent Gallup poll shows that an increasing number of people believe they pay too much in taxes, with the fewest Americans since 2001 believing that the amount they pay is fair.

If you're still in shock from the amount of taxes you just had to pay, you should start working now to reduce your tax bill for April 2014 and beyond. Here are five ways you can get on track to write a smaller check to the IRS next year.

1. Put more money toward your retirement. The best way to shrink your taxable income is to save for retirement using IRAs, 401(k) plan accounts, and other tax-favored retirement savings accounts. This advice tops our list because the amounts you can save are big enough to have a real impact on your taxes. Those younger than age 50 can save $17,500 in a 401(k) plan this year and another $5,500 in an IRA. If you're 50 or older, those limits are even higher, topping out at $23,000 for 401(k)s and $6,500 for IRAs. Using them in combination can cut thousands off your tax bill.

2. Hold onto winning investments longer. When the stock market is rising, many people sell off their winners quickly to make sure their paper gains don't turn into losses. But that short-term mentality leaves you paying much higher rates on short-term profits, with some taxpayers losing more than half their gains to federal and state taxes. If you hold onto winning investments for more than a year, you'll qualify for much lower long-term capital gains rates, which can cut your tax bill on those gains in half -- or even eliminate it entirely for some lower-income taxpayers.

3. Take a look at tax-free municipal bonds. With interest rates as low as they are, paying taxes on the paltry amounts of income you can earn from bank CDs and most bonds just adds insult to injury. But especially if you're in a fairly high tax bracket, you'll want to take a closer look at tax-free municipal bonds for income. Right now, the muni bond market is in a somewhat unusual position in which yields are actually higher than what you'll get from Treasury bonds or FDIC-insured bank accounts, even before you take their tax advantage into account. So don't ignore municipal bonds as a potential source of valuable income as well as tax savings.

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4. Boost your withholding. If you didn't have enough taken out of your paycheck last year, you not only had to write a big check at the end of the year but also might have owed penalties and interest. Pushing up your withholding to have enough money held back to avoid penalties is a smart move. Just remember that having too much withheld is also a mistake, as it essentially gives the IRS an interest-free loan from your hard-earned wages.

5. Get familiar with tax credits and deductions. The tax code has a wide variety of provisions that let you cut your tax liability, but if you don't know about them, you can't take advantage of them. Deductions and tax credits are available on expenses ranging from child care costs and donations to charity to spending on energy-efficient home improvements, so be sure to take maximum advantage of the spending you're already going to do this year.

Get Started Today

The longer you wait to take these tax-saving steps, the harder it'll be to get everything done in time to avoid another big tax bill next year. If you act now, it will be a lot more painless, and the results will be much more to your liking when tax time rolls around again.

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