Getting an income tax refund can be both exciting and stressful at the same time. Many generally don’t know what to do with the sudden and possibly unanticipated windfall. There are numerous options to use the money. For example, should you save it? Should you spend it freely or invest the money? While some choices could boost your financial situation, others can give you a short trip or the phone that you have wanted for some time. You all would get surprised to know that an income tax refund could make you feel rich and push you to spend freely on unnecessary things. According to professionals, taxpayers should remember that this isn’t additional cash; the government isn’t sending you a bonus check; it’s your own money. Moreover, treat your refund like your monthly paycheck and give it a purpose. You can also determine your financial priorities and utilize the funds. Hence, if you are expecting or have received a tax refund this year, make a plan for it in advance so that you fill in the gaps in your financial life before splurging. In this blog, we will learn some sneaky ways to get more back on taxes 2022.
We all talk about retirement contributions and how we can save you a ton of money when the tax time comes. However, not all retirement plans are made equal. For example, if your retirement plan has the ‘Roth’ designation, meaning that you are paying tax on the income that you use to fund your retirement, with the intention that when you retire, you will make tax-free withdrawals from your retirement account. However, if you just have a standard IRA, it means your contributions are reducing your taxable income. So, let us browse some examples.
You make $50,000, meaning you will pay about $4,400 in taxes this year. However, you decide to contribute $5,000 to a Roth IRA, which will cause no difference to the bill. Also, you can withdraw whatever you have contributed to your Roth IRA and not pay any taxes on it when you reach retirement. Thus, if your $5,000 grew to be $20,000, you can take those $20,000 without paying any taxes.
Suppose you make $50,000 and pay $4,400 in taxes; however, this time, you decided to contribute $5,000 to your IRA, reducing your taxable income by $5,000. Now, you are only being taxed on $45,000, which would reduce your tax bill down to about $3,800. So, only by saving $5,000 towards your retirement, you save a surplus amount of $600 on your taxes.
Clear Off Debt
Clearing your existing dues is one of the most important things you do with your money. You should never invest or save your money when you owe it somewhere, primarily if it includes you paying an interest of 30-40 percent per annum.
Existing dues generally include outstanding credit card payments, car loans, personal loans, and many more. Moreover, if you have multiple dues, start clearing off in order of interest rates, dues with higher interest rates and no tax benefits go first, and the ones that offer several tax benefits such as home loans and student loans should be kept for the last. Furthermore, check for pre-payment charges.
College Savings Plan
College savings plans are considered a great way to set aside funds for everyday educational expenses. Due to the Tax Cuts And Jobs Act, 529 plans can now be used for any educational cost, be it college. This generally includes uniforms, school books, tutoring, field trips, and many more.
If you know that, on average, your kid’s school costs around $7,000 per year, you can effortlessly turn that expense into a tax deduction by first making a $7,000 contribution to their 529 plan. This would help in reducing your taxable income by $7,000 without having to change any of your spending patterns.
While the IRS does not primarily limit contributions to 529 plans, the annual reward tax applies to gifts given in addition to $15,000, meaning that you can contribute up to $15,000 per child every year without incurring a gift tax. Your partner can contribute another $15,009 per year, per child, without incurring the gift tax either. Furthermore, you can also make a huge contribution in the amount of $75,000 to cover a five-year period.
Ultimately, the amount that can be accumulated in a 529 plan is set by the state, while overall contribution limits vary by state and can range from $235,000 up to $520,000. Moreover, some states also offer state tax credits or deductions that can be applied to your state income tax return.
Replacing Wage Income With Non-Wage Income
This is considered one of the hardest tax tips. This requires you to make investments in either tax-advantaged or tax-free assets. These generally include municipal bonds, which are tax-free or standard stocks, and tax-advantaged bonds. Let’s try to understand with the help of some examples.
The interest that you get from owning municipal debt is generally tax-free. So, if you put $100,000 in municipal bonds that pay an interest rate of 5%, you will be earning $5,000 every year, none of which you will have to pay any tax on.
Stocks And Bonds
Investing in bonds and stocks can have a huge tax benefit if done correctly. Moreover, it will provide a good source of income. If you were to put in an index fund that pays dividends, you could earn around 2% each year plus appreciation. Also, you will only be taxed at the long-term capital gains rate of 15-20%.
If you were to accumulate $1 million in a fund that pays 2% in dividends, you would have to pay around $3,000-5000 in taxes. Moreover, if you are earning $25,000, you are paying an effective rate of about 23.8%. Thus, by changing your source of income from salary to investment income, you are limiting your tax rate to 20% instead of potentially climbing into the top tax bracket.
Knowing Ins And Outs Of Your Industry
Having a good idea of the ins and outs of your industry could help in saving thousands in tax savings. For example, did you know that on average, gas taxed at around $0.50, and out of that, local and state taxes were about $0.31? Also, could commercial fishers apply for a refund on those local and state gas taxes in Florida? Thus, knowing the ins and outs of your industry can be very lucrative when maximizing your income tax refund.
Increase Equity Exposure
Keeping the money lying in a savings bank account is never the best idea. You can invest the lump sum money in a debt fund and slowly move the money to an equity fund. You could also put the funds for a long-term goal a few years away. Moreover, the funds can be used to make down payments for big purchases and reduce your loan burden.
If you are looking for how to maximize your income tax return for quite a long time, you can go for both life and health insurance covers as per your situation and needs.
If you are one of those who buys an insurance plan and then lets it lapse by missing the premium deadline, you can opt for a single premium term plan. With this policy, you can make a one-time payment, and your insurance cover will be taken care of till you retire. Even though the one-time premium option helps you keep financial discipline, it is not considered cost-effective.
On the other hand, health insurance cover is necessary, given the high medical costs. The employer’s insurance policy may not provide full coverage if you have a family. Hence, it is better to opt for a family floater plan for all your loved ones. Moreover, a family floater plan is considered an ideal option for young nuclear families but keep in mind that it is shared between the members.
Head over to the Business Tax Benefits website to know more tips to maximize your income tax return. You can find lots of information regarding the CARES Act and Employee Retention Tax Credit. Our tax experts strive to help businesses flourish and grow.