The complex world of taxation can be daunting, especially when the stakes are high. Overpaying taxes is a common pitfall for many, particularly those unfamiliar with the finer details of tax deductions, credits, and strategic planning.

Fortunately, understanding how to minimize tax liabilities legally can save you thousands. Here’s how to stop overpaying taxes while ensuring you stay compliant with IRS regulations.

Maximize tax deductions and credits

Deductions and credits can be used to reduce your tax bill, but taxpayers often overlook this option. Deductions reduce your taxable income, while credits reduce your tax liability directly. In 2023, the average taxpayer failed to claim about $1,000 in potential tax savings. This underscores the importance of knowing what’s available.

Key deductions include medical expenses, student loan interest, and mortgage interest. As of 2024, taxpayers can deduct up to $750,000 in mortgage interest, provided the loan was incurred after December 15, 2017. Meanwhile, tax credits such as the Earned Income Tax Credit (EITC), can provide substantial savings.

According to IRS data, 23 million eligible Americans claimed $57 billion in EITC in 2023, averaging a refund of around $2,400 per family. By claiming all deductions and credits applicable to your situation, you ensure you aren’t leaving money on the table.

Invest in retirement accounts to lower taxable income

Contributing to retirement accounts such as a 401(k) or IRA is one of the most effective ways to lower your taxable income. These contributions are often tax-deferred, meaning you won’t pay taxes on the money you invest until you withdraw it in retirement.

For 2024, the contribution limit for a 401(k) has risen to $23,000 for those under 50 and $30,000 for those 50 or older. Traditional IRAs also allow deductions of up to $6,500 ($7,500 for those over 50), depending on your income.

Not everyone maxes out their 401(k) contributions, which means a missed opportunity for tax savings. By maximizing these accounts, you can significantly reduce your adjusted gross income (AGI), which in turn reduces your tax liability.

Utilize Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs)

Health-related savings accounts like HSAs and FSAs offer another underutilized opportunity for reducing taxable income. Contributions to these accounts are made pre-tax, and withdrawals for qualified medical expenses are also tax-free.

As of 2024, the IRS raised the HSA annual contribution limit to $4,150 for individuals and $8,300 for families. A March 2024 report by the Employee Benefit Research Institute found that account holders are making more use of HSAs. In fact, investments increased for the sixth year in a row, but only 13% of these account holders invested in assets other than cash.

This means that many are still missing out on both tax savings and long-term medical security. HSAs are particularly advantageous for high-deductible health plan holders, as they also offer the benefit of investment growth, which remains tax-free if used for medical expenses.

Flexible Spending Accounts (FSAs) operate similarly, allowing employees to set aside pre-tax dollars for health care or dependent care expenses. FSA contributions are capped at $3,050 for healthcare, but that limit is soon to be raised to $3200. This means that taxpayers can save on medical costs while lowering their taxable income.

Capitalize on tax-loss harvesting

For those with investments, tax-loss harvesting (TLH) is an advanced technique to reduce your taxes by offsetting capital gains with capital losses. If you’ve sold assets like stocks or real estate at a loss, those losses can be used to offset other taxable gains in your portfolio. If your losses exceed your gains, you can deduct up to $3,000 from your ordinary income per year.

Tax-loss harvesting is a missed opportunity for many, as the IRS allows capital losses to be carried forward indefinitely. So if you have substantial losses, you can use them in future years, further reducing your tax burden. Earlier in 2024, Vanguard found that TLH alpha—the potential additional annual after-tax return—ranged between 0.47% and 1.27%.

However, it is important to remember that the IRS’ wash-sale rule forbids claiming a loss on the sale of an investment if the same or “substantially identical” investment is acquired either 30 days before or after the sale date.

Violating this rule disqualifies the capital loss deduction, which can be costly. Nevertheless, 2024 saw more investors showing an interest in low-cost ETFs. Low-cost core bond ETFs, in particular, emerged as a vehicle for building more cost-efficient portfolios while retaining asset class exposure.

Work with a tax professional to optimize your strategy

While self-filing might seem appealing, the complexity of tax law often leads to missed deductions and overpayments. Working with a qualified tax professional gives you the opportunity to take advantage of every deduction, credit, and legal tax shelter available to you.

A 2023 IRS report found that people who worked with a tax advisor or certified public accountant (CPA) saved an average of $850 more than those who filed on their own. The complexity of tax law—especially for business owners, high-net-worth individuals, or those with multiple income streams—makes professional advice invaluable.

Additionally, experienced tax advisors like David’s Family CPA can help you stay ahead of upcoming tax law changes. With potential tax reforms on the horizon for 2025, staying informed can help you adjust your strategy. Working with a professional enables you to remain prepared for these shifts while minimizing the risk of over-taxation.

Future-proof your finances

With some work you can avoid overpaying on your taxes, by tapping into available deductions, credits, and investing in retirement accounts, and more.

It is worth noting that with tax-loss harvesting, investors need to have the discipline to invest tax savings in the market to fully reap the rewards. Many investors find it challenging to predict their future tax rates when they know their circumstances or earning power is likely to change drastically over time.

Seek expert advice to optimize your tax strategy over time.