How To Minimize Tax Debt
Paying taxes isn’t fun, but ignoring them can lead to something worse — tax debt. Tax debt results when you fail to pay federal or state government taxes on your earned income. When you don’t pay your tax debt, you’ll face stiff penalties, including wage garnishment, property levies and even jail time in some circumstances.
Related: What To Do When You Can’t Pay Your Tax Bill
One way to avoid tax debt is to figure out how to pay less in taxes. If you do find yourself in debt with Uncle Sam, explore tax relief solutions and ways you can settle it — maybe even for less than you owe.
Here’s a quick look at what you’ll find in this guide to minimizing tax debt.
Ways To Minimize Tax Debt
Even if you have outstanding tax debt, it’s important to reduce your tax liability by discovering how to pay less in taxes. One way to do this is by lowering your adjusted gross income. Your adjusted gross income is the amount that’s left after you subtract certain allowed deductions from the income you earned during the previous year.
Your adjusted gross income determines which tax credits and additional deductions you qualify for that can further reduce your tax bill. For example, a married couple with one child and an adjusted gross income of $46,884 or less may qualify for the earned income tax credit.
You can lower your adjusted gross income by reducing your taxable income. This includes taking advantage of certain tax credits and deductions available to you.
Reduce Your Taxable Income
You can deduct certain contributions from your taxable income, which reduces your tax liability. Some ways to earn tax-free income include contributing to a health savings account, putting money away for your children’s education in a qualified plan, investing in municipal bonds, spending some of your earnings on out-of-pocket health costs and passing some of your investments to your children. In addition to helping you avoid tax debt, these options can help you save money for future expenses or benefit your children or family.
Good To Know: How Do Tax Deductions Work?
Claim Every Tax Credit You Can
Unlike tax deductions, tax credits reduce tax debt dollar for dollar because you subtract them from the amount of tax you owe. Tax credits currently in place include credits for owning energy-efficient property, pursuing education and adopting a child. Although you shouldn’t make purchases you don’t need just to get a tax credit, these credits are a nice benefit if you do happen to have room in your budget for these expenses or have these activities in your plans.
See: 3 Tax Credits Every Parent Should Know
Take Every Available Tax Deduction
Deductions lower your tax liability because you subtract them from your income. The more deductions you claim, the less tax you’ll pay. Many itemized deductions are available, from business expenses and home mortgage interest to property taxes and charitable donations. A tax software program can help you determine which deductions you can take.
Make sure you explore all of your options and take the deductions to which you’re entitled. Although you can claim deductions even if you don’t have receipts for them, the IRS recommends keeping what it calls “full and accurate records.” This includes receipts, but you may have other forms of recordkeeping, such as a spreadsheet of home improvements.
Find Out: What New Homeowners Need To Know About Taxes
Review Your Filing Status and Exemptions
Your tax filing status affects how much you pay in taxes and helps determine your tax bracket. You can use your filing status to calculate your standard deduction, personal exemptions and income levels for phase-outs of your itemized deductions and personal exemptions.
You must know which tax exemptions you are entitled to take, too. For instance, there are personal deductions for married couples and dependent exemptions. Again, a tax software program can help you easily figure out which deductions you qualify for and which make the most sense.
Defer Your Taxes
Think of deferring your taxes as getting a government loan — for free. You can defer your taxes by investing in an individual retirement account or another tax-deferred retirement account like a 401(k) and postponing your bonus from your employer.
But contribution limits apply to IRA and 401(k) accounts, and your employer might not agree to postpone your bonus until the following year. Also, it only makes sense to delay your bonus if you think you’ll be in the same or lower tax bracket next year. Otherwise, you risk being hit with a larger tax bill than if you didn’t defer.
See Next: 9 Legal Tax Shelters To Protect Your Money
Ways To Settle Tax Debt
Sometimes tax debt is unavoidable. You may miscalculate your deductions and credits, earn more income than you expected, inherit money or learn that the IRS found a mistake in a previous return. If this happens to you, don’t panic and don’t ignore it. There are ways to settle the debt with the IRS.
Ask For an Offer in Compromise
An offer in compromise enables you to settle your tax debt for less than you owe. To qualify for an OIC, you must have filed all your tax returns, received a bill for the tax debt and made your estimated tax payments for the current year. If you’re a business owner with employees, you must have made your federal tax deposits for the current quarter.
To apply for an OIC, complete IRS Form 656 along with the supplemental Form 433-A or Form 433-B. Submit the $186 application fee, an initial payment offer and supporting documentation with the applications.
Check Out: How To Avoid Paying Taxes Legally — and the 11 Craziest Ways People Have Done It
Apply For an Installment Agreement
In case you can’t pay your tax debt immediately, you can make monthly payments through an IRS payment plan — also known as an installment agreement. Going this route will enable you to lower or eliminate any penalties or interest as long as you eventually pay off your debt in full.
Before you apply for an IRS tax payment agreement, confirm you’ve filed all your required tax returns. Follow these steps to apply for an installment agreement:
Complete and mail Form 9465, Installment Agreement Request and Form 433-F, Collection Information Statement.
Call 800-829-1040 or the phone number on your bill or notice.
Follow further instructions from the IRS.
Take Out a Loan
Sometimes it’s easier to take out a personal loan to pay for your tax debt. Depending on your credit history, you may qualify for interest rates and terms that make the loan less costly than paying through an installment agreement with the IRS. With a loan that covers the entire cost of the tax bill, you may find some peace of mind knowing that you don’t have to deal with the IRS anymore.
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Last updated: May 10, 2021
This article originally appeared on GOBankingRates.com: How To Minimize Tax Debt
