Tax laws in the United States are complex and it’s one of the many reasons there are as many tax loopholes that are. However, it’s also why myriad taxpayers wind up paying more money than they need to and why it’s advisable to enlist the services of an experienced financial advisor to maximize your tax strategy and reduce your tax liability.
Generally, a tax loophole refers to a provision in the tax code that enables taxpayers to lower their tax liability. The middle class can gain access to many of these loopholes. All you need to do is be aware of them. Below are some tax loopholes for every one to take advantage of.
1. Deductible IRA Contributions
If you have a 401(k) through work and finance it with pre-tax money, it automatically decreases your taxable income. If you are in the middle or low-income category, you can obtain an even bigger tax break by making traditional IRA contributions. In turn, you will take an above-the-line tax deduction when filling out your tax returns.
To this end, such contributions will reduce your taxable amount by the amount you donate. This is especially helpful if your income is on the cusp of a higher tax bracket. Alternatively, a wealthy person who makes traditional IRA contributions will not reduce their taxable income in the same manner.
2. Home-Sale Exclusion
When you sell your home for a profit, you will not be in debt to the Internal Revenue Service (IRS) for long-term capital gains taxes on the first $250,000 in profit or $500,000 for joint filling by a married couple. Since most middle-class individuals will not realize more than $250,000 in profit from a home sale, the home-sale exclusion provides an excellent tax loophole for them. To this end, this is why buying a home makes financial sense.
3. Child Tax Credit
When a low or middle-income earner gets a new baby, they can claim a $2,000 child tax credit annually until their dependent child turns 17. Despite the time and day the child is born, you will get the entire $2,000 credit. In turn, this will reduce your tax bill by $2,000, but it disappears once your income goes beyond $200,000 on head-of-household and single returns and $400,000 on joint returns.
It is also worth noting that there is no limit to the number of children you can claim on a return, so long as they qualify. To this end, if the $2,000 child tax credit is more than your income tax liability, the IRS will refund you the difference. More so, some low-income taxpayers can get the credit refunded (up to $1,400 per qualified dependent child).
4. Earned Income Tax Credit
If you are employed but not earning much, you have the choice to claim for the Earned Income Tax Credit (IETC). This credit is refundable, unlike the Saver’s Tax Credit. Similar to other tax credit options, EITC directly decreases your tax liability by the size of the credit. If the amount of the EITC is more than the amount you are in debt in with the IRS, the IRS will refund you the difference. In this case, the EITC has been very victorious in decreasing poverty among many working-class families.
5. Saver’s Tax Credit
If you are a working-class American who has managed to put away some savings can claim the Saver’s Tax Credit when filing their returns. It is a tax loophole designed to allow people to gain an incentive to save money. This especially comes in handy when people have insufficient or zero retirement savings or lack an emergency fund.
But, it is worth noting that Saver’s Tax Credit is non-refundable. It can also decrease your tax bill to zero, but only if your credit amount is less than what you owe the IRS. Otherwise, you will not receive the refunded difference.
Due to the complexity of the US Tax Code, a few things will always manage to slip in through the cracks. Middle-class and low-income individuals can take advantage of various tax breaks and attain their retirement and investment goals. If you are looking to reduce your tax burden, it is advisable to find a financial advisor.
Photo by Önder Örtel