How to Reduce Taxes in 2020 | Stop Overpaying Taxes

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Is it possible to not have to pay any taxes? Do the rich pay a lower percentage of taxes than the average American? Can you as an average-earning American figure out how to reduce taxes in 2020?

The short answer to all these questions is, yes. However, there’s a lot more that plays into this than a simple, “yes”.

The truth is that the only reason the rich can avoid taxes is simply that they understand tax laws. They take the time to study them and set themselves and their income up in a way in which they don’t have to pay as much in taxes.

Are the rich able to do this only because they’re rich? The answer to that is a resounding, “no”.The average American can also find a way to reduce their taxes. The rich do it legally, and so can the average American.

The key is to learn how. In this article, we’ll be going over strategies you can utilize to minimize the taxes you owe on your income.

With this being said, keep in mind that the information given here is general. You should consult a trusted, licensed CPA or tax advisor for your individual tax information. Your results can vary depending on several factors relating to your lifestyle. Use the information here to get started on minimizing your taxes, but again, keep in mind that results vary depending on your situation.

Just like the rich can use the knowledge they have to minimize their taxes, you too can have the knowledge to minimize your taxes according to your lifestyle.

Tax Brackets

The key to paying fewer taxes, other than learning the laws, is to make your income look as low as possible, without actually reducing your income. In America, we have tax brackets. Your income puts you in a specific tax bracket.

The tax brackets go as follows:

Source: https://www.nerdwallet.com

How do tax brackets work? Very simple, the taxes you owe/pay are based on your earned income. This means that, for example, if you are single and you make $40,125 annually, you would be in the 12% tax bracket. This is considered your marginal tax rate.

This means you pay federal income taxes of 12% of your annual earned income at the end of the tax year. More details on tax brackets are available in a separate article.

Your marginal tax rate is based on your earned income. Oddly enough, there are three types of income for tax purposes. They are, earned income, passive income, and portfolio income.

In this article, we’ll be focusing on earned income.

#1. Long-Term Capital Gains

Keeping your investments for longer than a year before realizing your profit is a great option for those who want to avoid large amounts of taxation on their investments.

When you realize a capital gain, it simply means you sold the investment and actualized its gain into monetary value. If you don’t sell the investment, even though it made profits, it is referred to as an unrealized profit or a profit on paper.

The reason why it’s a great option to take long-term capital gains is that they are not taxed at your standard marginal tax rate. Short-term capital gains are the profits you have when you sell an investment before 1 year and 1 day. They are taxed as regular income. Long-term capital gains are only taxed at:

  • 0% for $0 to $40,000 income
  • 15% for $40,001 to $441,450 income
  • 20% for $441,451 or more income

There are specific strategies one can utilize to avoid that 20% tax rate on large amounts of long-term capital gains. This is more specific to those who have large profits in retirement after several years of investing but we won’t be going over those here.

Taking long-term capital gains is a method that any smart investor can take to avoid large taxes on what they make from investments. As said before, if you were to sell your investment before 1 year and 1 day of buying them, then your capital gains would be taxed as regular earned income rather than portfolio income.

#2. Standard Deduction

Standard deductions are simply cuts you can make in your taxable income to make it look like a smaller portion of income. Most people take a standard deduction when filing their taxes but there are few that don’t.

Some people make itemized deductions but this is generally the lesser of the two options because itemized deductions tend to be lower than the standard deduction.

People don’t usually familiarize themselves with either of these options. Sometimes, you’ll have people who don’t take either of these deductions and end up paying more taxes than necessary, simply because they aren’t educated on these common deductions.

The standard deductions are as follows for the 2020 year:

  • For single taxpayers or married individuals filing separately, the standard deduction is: $12,400
  • For married couples filing jointly, the standard deduction is: $24,800
  • For heads of households, the standard deduction is: $18,650

A simple example using the information above can be:

A single person who earns $40,000 a year can take the standard deduction and show the IRS that they only earn $27,600. Thus, making only $27,600 taxable income, instead of the entire $40,000.

Taking a standard deduction can save you a large amount of money every time you file your taxes. All you have to do first is know they exist!

#3. Max Out Retirement Accounts

Retirement accounts are another huge advantage you can take to minimize your taxable income. Depending on your situation, there are a number of options you can choose.

Keep in mind that you can take advantage of these but some are only under certain circumstances.

  • Traditional IRA – IRA stands for Independent Retirement Account. This account is one in which you can contribute pre-tax dollars to invest for retirement. You can contribute a max of $6,000 (for the year 2020). By making contributions to your Traditional IRA, you minimize your taxable income by $6,000 annually, thus owing less on taxes.
  • Traditional 401k – A traditional 401k is offered by your employer. It is a retirement account on which you can contribute an annual maximum of $19,500 (for the year 2020). Just like a traditional IRA, you contribute pre-tax dollars to this account. Reducing your taxable income as a result.
  • Solo 401k – This is a 401k qualified retirement plan for self-employed people. They may not have any employees other than the business owner and their spouse. A solo 401k also has a maximum annual contribution limit of $19,500 (for the year 2020), just like a traditional 401k.
  • 457b Plan – This plan is only offered to government employees and is very similar to the 401k with its annual contribution limits and its pre-tax contributions. The advantage of this plan is that you don’t need to wait until the age of 59.5 to make withdrawals. You can make withdrawals before that age and not get penalized for it.
  • HSA Account – HSA stands for Health Savings Account. This account is one in which you can make (again) pre-tax contributions. You can contribute an annual maximum of $3,550 (for the year 2020). All withdrawals within this account are completely tax and penalty-free as long as you make withdrawals for qualified health expenses after the age of 65. One caveat is that you need to have a high-deductible health insurance plan to be able to qualify for this account.

With each of these accounts you have the opportunity of making contributions with pre-tax dollars. You have the option to contribute to more than one of these accounts per year depending on your circumstances.

When you contribute to these accounts, you reduce your total taxable income and legally save yourself a large sum of money that could’ve gone toward taxes.

Traditional IRAs are taxed on their gains when you make withdrawals, but if you take advantage of the Roth IRA Conversion Ladder you can have your pre-tax contributions completely tax free.

#4. Invest in Municipal Bonds

When you buy a bond, you are effectively lending money to an entity for a pre-determined time. The entity provides interest payments on your principal (the amount that you bought the bond for). After the maturity date of the bond is reached, the entity pays back your principal in full, assuming they didn’t default.

Bonds have a certain level of risk but are considered to be less risky than stocks. The more risky an entity, the greater the interest they will be paying on your principal, and vice versa.

If the entity you buy the bond from is not government-related, chances are that the interest payments on your principal will not be tax-free. Unless you make the investment within a tax-advantaged account. Otherwise, the bond will be prone to taxes; these bonds are usually corporate bonds.

Municipal Bonds are government bonds rather than corporate bonds. The interest payments they give are federally tax-free. However, they might be prone to state and local taxes depending on your state.

Municipal bonds tend to pay a lower interest rate on your principal because they, historically, posses a very low default rate. Their default rate is 0.1% compared to 2.28% for corporate bonds. Since they are a safer investment, they don’t usually pay as much interest as corporate bonds.

This is why you should always make sure that the tax you’re saving from municipal bonds compensates for that smaller return. As a bondholder, you should understand your tax-equivalent yield to ensure you’re getting the best deal for your bond. The higher your tax bracket, the higher your tax-equivalent yield.

A tax-equivalent yield is a pre-tax yield that a taxable bond must possess for its yield to equal that of a tax-free municipal bond. Before you invest in municipal bonds, make sure to understand your tax-equivalent yield to see if it’s worth it to invest in municipal bonds.

#5. Start Your Own Business

Starting your own business is one of the best options to legally avoid taxes. Not everyone is on board with starting a business but it is worth noting that owning one can put you in a big tax advantage.

By carefully following IRS guidelines, a business owner may be able to deduct part of their home expenses with the home-office deduction. Any utilities used for the business can also be deducted from your income.

There are a number of interesting deductions you can make when it comes to business ownership. Some of these deductions include, but are not limited to:

  • Self-Employment Tax
  • Travel
  • Education
  • Vehicle Use
  • Rent
  • Home Office
  • Meals
  • Start-Up Costs
  • Insurance

An individual business owner can also choose to run their business through something called an S-Corp. All the business income you make goes into the S-Corp, and all business expenses come out of the S-Corp. When you do this, the S-Corp becomes a hub of doing business. You are paid directly from the S-Corp into your own personal account.

Effectively, with an S-Corp, you become the “employee”, and the S-Corp becomes your “employer”. You get paid a base salary as an employee of the S-Corp and any money that’s leftover is paid to you in a form of a distribution.

These distributions are not subject to medicare or social security taxes. This can save you about 15.3% on taxes, according to irs.gov. The intricacies of running your business through an S-Corp are highly technical and you should consult a professional CPA to get started with this if you’re currently self-employed.

This leads me to my next point!

Make Sure To Hire A Good CPA or Tax Advisor

All the information provided here is to demonstrate that there are advantages that you can take as a taxpayer to avoid overpaying taxes. These are benefits that most people don’t take advantage of because they’re simply not aware of them. Due to their lack of knowledge, they end up paying more in taxes than they should or could at the end of the tax year.

After learning the information given here, your next move should be to consult a trusted licensed CPA or tax professional to ensure that, under your given circumstances, you are able to take all the advantages you can to legally reduce taxes.

I want to reemphasize that the CPA or tax advisory you choose should be well trusted. Make sure they have your best interest, ensure they go over all the details of how you can lower your taxes under your given circumstances.

While CPAs can be a great resource, some CPAs only care about getting the job done as quickly as possible with a client and don’t show the client all the options they have available. Sometimes they may not even know that the client has certain options available because the client doesn’t know about them and, as a result, never discusses them.

Discuss how you can take advantage of some (or all) of the tips given here. Do they apply to your individual circumstances? Can you take advantage of extra perks to reduce your taxes? If you can, take advantage of them ASAP! It will save you tremendously in the long run.

Let me know in the comments below if you think you think you can take advantage of some of these. I’d be glad to hear the options that helped you out today.


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28 Comments

  1. Thanks a lot for sharing this article, it can really get choking sometimes paying your taxes and that’s a necessary things to do because you don’t wanna stay without paying it. This article is very resourceful and I like the ways you’ve included in it, makes it easier to understand and it is very practical. Thanks

    1. Of course! Glad it was helpful 🙂

  2. This is a very informative tips that can really help to ensure we have some money with us going forward. Being able to actually mitigate the amount of money we render as payment fro tax can be quote daunting. Hence, this is really good to see here and it makes a lot of sense. Thanks so much fo all you have shared here. Thumbs up to you here

    1. I appreciate your feedback and I’m glad this was helpful 🙂

  3. Paying taxes is a normal idea which everyone does and in that line, the government makes money with your taxes when they, in turn, use it to develop the country. However it’s sad to he paying high taxes and not even know why. With these good tips it would save me some extra Cash and I’m really happy with it

    1. Of course Justin! I’m glad this was helpful 🙂

  4. This is some very good points on how to be able to reduce the payment of taxes in this year. I think the year has really had a big toll on everybody and there was no normal flow of income for a very larger part of the whole pandemic. It would be very nice for me to use what I have learnt here to reduce tac payment.

    1. I agree, but it’s not too late! You can certainly use it for next year and the following years! Start now, and you will appreciate it greatly in the future 🙂 Thanks for the feedback

  5. Wonderful, I have always been interested in taxes and reducing them so am pleased to have found your article in search.
    I know of the Australian taxation laws which are very complex, and have always been curious as to how the taxes in the USA worked.  And I must say, your article explained this very simply and clearly.
    I was surprised by the similarities
    1. Long term capital gains get tax concessions.  In Australia its a flat concession, in the USA its a marginal (progressive) basis, so naturally there will be more strategy around this, in terms of how much gains you choose to realise in a given tax year e.g. shares/stocks.

    Standard deductions is fascinating.  It is very high to be $12,400, it is almost another policy way of saying what the tax free threshold is. In the USA it is NIL, but in Australia it is A$18,200 without a “standard deduction”.  They both achieve the same policy outcome.  Another difference that can result in planning and structuring opportunities is the simple options of single, married and head of household.  Again this is another policy quirk the US tax policy boffins introduced at some stage that give people choices to play with.

    Retirement accounts.  Even more permutations in the USA, with the addition of the Health Savings Account.  I can see why people will be incentivised to throw money into combinations of say 401K, IRA and even HSA, if I understand all that correctly. Then there is municipal bonds.

    Home based business allow a lot of tax deductions, this is great as it encourages entrepreneurship, which society needs especially in these pandemic times.

    You mention that individual business owners can also choose to become an S-Corp, so is the other option just to do it on your own name and deduct the expenses against say your business income in your own name OR are you also able to deduct the expenses against your employment income?

    I can certainly see the need for a good CPA as this would be complex for most people.
    Great read & I feel I learned all the core rules from this.  Thanks John

    1. Hi John, thank you so much for this detailed feedback! I’m glad to have provided you and others with this information. I find it so interesting to see how the tax laws are so different from country to country, in your case Australia. 

      I can see that when it comes to comparing the two, with US tax laws there is a lot more strategy involved concerning the reduction of taxes. For example, the marginal tax basis. That’s very different here and in Australia from what you’re telling me.

      From what I can see, standard deductions differ tremendously between the US and Australia, the quirks offered in the US really give us the opportunity to slip through the loops, the trick is learning about the loops first!

      When it comes to retirement accounts, people are incentivized to take advantage of retirement accounts like IRA, HSA, or 401k but, unfortunately, they aren’t mandatorily taught about this (at least in the US).

      And yes, entrepreneurship is highly encouraged. There are tremendous amounts of benefits in starting a business. However, to answer your question about running your business outside of an S-Corp, there are many ways in which an individual can take make deductions. The first option you mentioned about deducting expenses against your business income is the most common. On the other hand, deducting expenses against your employment income is usually not an option, of course, there are always loopholes and there could be particular circumstances where you MIGHT be able to make certain deductions against your employment income. 

      This is why I always recommend getting a trusted CPA to help you with your taxes. There are many advantages in the US that we can take but we have to make sure that our CPA cares enough to explain them in detail.

      Again, thank you so much for your feedback. I’m very happy to provide this information. I’m not very familiar with Australian tax laws so I’ve learned a lot just from your comment. Thank you 🙂

  6. Hello,

    In my research, many people unwittingly overpay on tax bills every year. I’m sure many people have wondered how they can lower their taxes every year. One of the major reasons people hate paying taxes is the mystery of it all, even with the help of tax preparation software, most of us still aren’t entirely sure that we’re taking full advantage of the law.

    Thank you.

    Aluko.

    1. Thank you Aluko 🙂 yes, this is why it’s important to get to know the tax laws of your country!

  7. Very useful tips on how to reduce tax costs. Since I started my own business some time ago, I have very well memorized the suggestions of what I can consider reducing my tax costs, some of these suggestions will come in handy.
    Wealthy people can afford to hire tax and financial advisers, and less wealthy people, if we are interested, can delve into things on our own, learning a lot and broadening our horizons.

    1. That is great to hear! I’m glad you’ve been using the perks of owning your own business to save you on taxes. And yes, less wealthy people have the option to learn more to save ourselves a lot of money in the long run!

  8. One of the the true ways to minimize your income tax exposure, is to make more money.

    I am aware that it seems a bit flippant but it is a valid fact. Tax laws in the US are created by the wealthy. And the rich and the corporations enforce those laws to be of benefit to themselves.

    What this actually entails is that lots of those millions of individuals at the lower end of the income ladder, have none of the advantages that allow those higher up the ladder, to cover some of their money from taxation. If you are in that less affluent level, the taxes you must pay are essentially “etched in stone” because the laws enforced by the wealthy, are not intended to be fair to you. 

    1. Joshua, thank you for your feedback 🙂 and I appreciate your dialectic comment! This is only true to a certain extent. US tax laws tend to favor or incentivize entrepreneurship. People who have their own business, even if it’s small, tend to have more perks available to them in terms of taxes. Whether the business owner is aware of them or hires a good professional that will take them through those perks is a different story. Nonetheless, the trick to paying less in taxes is to make your income look less to the IRS than what it actually is (legally of course). Many of us have the power to do this but lack the knowledge to put ourselves in the position to pay fewer taxes. Rich people are rich because they learn and implement. Something that the average person doesn’t want to do, unfortunately, because of laziness. 

      In the US, even the average-working-American has advantages that they may not be aware of. The methods I listed here are ones that can be taken advantage of by ANY American. Something great about the United States is that anybody has the opportunity to grow financially with a business. In fact, this nation enforces that with its advantageous tax laws. We as Americans should be open-minded to learning more about our laws and what we can take advantage of, if possible and if driven maybe even start a business. Instead of complaining about who has more and who has less, let’s focus on ourselves and find out how to come out ahead without pointing fingers at those who have worked hard to get in their positions.

      Thank you, again, for your comment!

  9. Paying taxes is necessary but I think everyone tries to minimize that, it wouldn’t be normal not to 🙂 What I find really unjust is that the more you earn the higher tax group you reach, to me it doesn’t make sense. Why should rich people pay more than a third of the amount they earn in taxes just because they are skilled, motivated, and sometimes work even harder than the poor ones?
    Your article is very useful for me as I like investing and I need this information. 

    1. Thank you for your feedback, I definitely agree that it is useful for us as taxpayers to minimize the amount of taxes that we pay every year. In terms of tax brackets, to me, it makes sense that you pay more in taxes as you earn more, simply because you CAN afford to pay more. Nonetheless, rich people understand the many ways they can get around these types of tax brackets. Thus, they don’t necessarily always pay accordingly to their corresponding marginal tax rate. By the way, I don’t think in any way that this is unfair to the common taxpayer, as we also have loopholes that we can take advantage of to minimize our taxes. Unfortunately, most people don’t take the time to learn about them. I’m glad this article was useful to you! 🙂

  10. It is great to know that you can legally reduce your tax bill. Although I’m reading this as a UK citizen, I think the principles are the same, or very similar. I, personally love the idea of building a business, as, apart from the tax savings, you are building a salabe asset for the future, if you decide to go down this path. 

    Other than that, investing into a retirement fund to cut your tax liability is also very appealing! Depending on your financial circumstances, of course. 

    This is a very well covered article, and a good starting point to saving your hard-earned income. 

    1. Hi! I’m very happy that this article is reaching people outside of the US as well! I’m not very familiar with UK tax laws but I’m sure you could take some of the stuff on here as you said and apply them to your area. I appreciate your feedback and glad to know this has been helpful to you even though you live outside of the US

  11. This is an awesome article. You basically wrote about the most important information on taxes for almost anyone to use. I find this very helpful. There are some things I didn’t know about. Having this information will make it easier for me.
    I am saving this page so that I can use it for reference to benefit the most out of my taxes.   Thank you!

    1. Hi John! Thank you so much for your feedback, I really appreciate it! I’m glad this served to be of great help to you!

  12. Thank you very much for this article, it is so informative taxes are one of those things you are not supposed to miss, I like the way you have narrated this article, surely thises are great points to be considered I appreciate it.

    1. Of course 🙂 I’m glad this has been helpful to you!

  13. Herbert Joseph Dilbert

    I am not a rich man. But I have known a few well-off people through the years. They tell me I that I have many reductions I can take. I never took it so seriously, I figured they were just saying these things to make it seem like what they were doing with their taxes was okay, even though I thought it wasn’t. Reading through articles like this one, I’ve realized that they were right all along. I remember them mentioning retirement accounts a lot, and I never took much interest in it. Now I see why they were so right about it. Thank you so much for this article. It has served a lot of value to my current research journey. Had to come down and leave you a comment because I really appreciate the help that you are providing for your audience. Hard to believe that it’s free!

    1. I’m glad you have decided to do a little research on your own for the upcoming tax year! It pays off greatly to hear that this information is helping people on their financial or research journey. I appreciate your comment, and wish you the best on your journey! 🙂

  14. Taxes are always an interesting topic where everyone has their own opinion. I didn’t not how tax reduction works in America, thank you for sharing this knowledge. I could use such an article on taxes in Europe. Here we also have a standard deduction on salary and additional deduction if you have kids in schools. It was interesting to read about max retirement accounts, I need to check for this option in our country. Very good article and advices – I will check what that I apply to my tax reduction in Europe.

    1. It’s always great to hear from people outside the globe running into these articles. I learn a lot from people like you! I specialize in US finances but it’s definitely interesting to read into the experiences outside of the US. Yes! I highly encourage looking into strategies to minimize your taxes within your region! Thank you for your feedback! Always great to hear from those outside 🙂

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