How To Avoid Tax

Strategies to legally avoid tax

There's a lot of truth in the old adage that there are only two certainties in life: death and taxes. But if you're wondering how to avoid tax, there are some strategies you can use to reduce the amount you pay and owe. There are two main ways you can legally avoid tax on your income: reduce your tax bracket, and/or take advantage of tax-sheltered investments.

Reducing your income bracket to avoid paying tax doesn't mean making less money. It just means you have to find ways to maximize your deductions and credits to bump your taxable income down to a lower level. This in and of itself is a complex proposition and should be approached with the help of an accountant or tax specialist, but it pays to know the major strategies you can use to avoid paying taxes.

Avoid Taxes Through Credits and Deductions

The best way to reduce your income tax is to take advantage of tax credits and deductions to lower the overall amount of taxable income you earn in a year. First, you need to understand the difference between a tax credit and a tax-deductible expenditure:

  • A tax credit is an expenditure that qualifies for a rebate on your federal tax return. For example, right now, the U.S. government is offering tax credits to homeowners who invest in energy efficiency. Thus, if you invested $1,000 in improving your home to make it more energy-efficient, you would be able to subtract $1,000 off your taxable income for the year by claiming the credit.
  • A tax deduction is an expense or donation that you can subtract from your overall income. If you run your own business or incur expenses for business purposes, these are usually tax deductible. Donations to registered charities are also typically tax deductible.

Investments that Help You Avoid Paying Taxes

A tax-sheltered Roth IRA account offers one of the best vehicles for avoiding income taxes in the United States. These retirement accounts allow you to make sizeable contributions without getting taxed on the money you put into it, or the income generated by the interest (with some exceptions). One way you can avoid paying taxes on any dividends you get from your stock investments is to funnel the dividends into your Roth IRA account. Similar strategies can be used if you have a 401k plan and want to maximize your contributions.

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