Legally and ethically lowering your tax can do wonders for your bottom line. Strategic tax planning enables you to keep more of the money that you worked so hard to earn. Practices for lowering your tax liability, from income and expense adjustments to maximizing deductions and credits, are discussed in detail below.
1. Maximize Retirement Contributions
One of the best possessions available for lowering taxable income is retirement accounts. With these, you make pre-tax contributions toward saving for retirement while also decreasing your taxable income on the year.
- 401(k): Up to the IRS annual limit ($22,500 for 2023, or $30,000 if you’re over 50).
- Traditional IRA: Up to $6,500 per year ($7,500 if you’re over 50) if you meet income requirements.
Pro tip: If you’re self-employed, consider the SEP IRA or Solo 401(k), which has much higher contribution thresholds.
2. Use Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs).
If you have a high-deductible health plan, then an HSA can be a tremendous tax-saving tool. You will get a tax deduction for your contributions. Withdrawals used for qualified medical expenses are deemed tax-free.
- HSA: In 2023, the contribution limit is $3,850 for individual coverage and $7,750 for family coverage, plus an additional $1,000 if you are 55 or over.
- FSA: You can contribute up to $3,050 to the tax-free fund for qualified health expenses in 2023, but you normally must use FSA money prior to the end of the year.
3. Max Out Your Charitable Donations
Donations given to qualified charities are those that can be deducted from your income tax to help lower it.
- Cash Donations: Up to 60% of your adjusted gross income can be deducted.
- Assets of Appreciation: If you donate appreciated stock or other appreciated assets, you will not have to pay the capital gain tax, yet you can take a deduction for its fair market value.
- Bunching Contributions: If you don’t itemize every year, consider contributing two or more years’ worth of donations in one year to push your total itemized deductions for that year over the standard deduction amount.
4. Take Advantage of Tax Credits
Tax credits directly reduce your tax bill dollar-for-dollar, whereas deductions don’t. Here are some of the most commonly used tax credits:
- Earned Income Tax Credit (EITC): EITC is aimed at low- and moderate-income workers. If it applies to you, it may cut down your tax bill or even be a basis for your refund.
- Child Tax Credit: You may receive up to $2,000 for each eligible child, a part of which can be refundable even if you do not owe taxes.
- American Opportunity and Lifetime Learning Credits: There are education credits available for tuition and related education expenses if you or your dependent is attending school.
5. Defer Income to a Future Year
This can help reduce your taxes by delaying income to a year in which you are in a lower bracket. Common ways to delay income include:
- Self-employed: Delay billing clients or hold off completing projects until the new tax year.
- Retirement Accounts: If you are near retirement age, you may not take withdrawals from retirement accounts until you reach the required minimum distribution age.
6. Harvest Investment Losses
Tax-loss harvesting is the selling of investments at a loss so gains can be offset. It helps in the capital gains tax reduction.
- Offset Capital Gains: Use losses against gains on a one-to-one basis. If losses exceed gains, the remaining losses up to $3,000 may be deducted against other income.
- Reinvesting: If you should sell a security at a loss, you may want to invest in a similar but different asset to maintain an analogous position in your portfolio without invoking a wash sale.
7. Harness business deductions if self-employed
If you are self-employed, then tax benefits will help you lower your tax in many ways.
- Home Office Deduction: If you have a portion of your home exclusively reserved for business use, one may qualify for the home office deduction.
- Business Expenses: Required business expenses such as office supplies, software, and marketing expenses shall be deductible.
- Vehicle Deductions: If you use your personal vehicle for business, you may take a mile-per-mile or dollar deduction for vehicle expense.
8. Consider Income Splitting with Family Members
Income splitting refers to transferring part of your income to family members who come in lower tax brackets. Your family’s overall tax liability will decrease.
- Employ Family Members: Whatever business you are running, hire your children. On their resultant income, further tax would be a liability at their taxable rate. You also could claim a deduction against their wages as an allowable expenditure for the business.
- Gift Transfers: You can gift up to $17,000 per person in 2023 with no imposition of the gift tax, which will help lower your future taxable income or assets.
9. Track and deduct miscellaneous expenses.
Although some unreimbursed work expense deductions for employees have been scrapped, there are still a number of miscellaneous deductions available. Examples include:
- Student Loan Interest Deduction: You may deduct up to $2,500 of student loan interest as an adjustment to gross income, even without itemizing.
- Gambling Losses: If you have gambling winnings, you may deduct your gambling losses, but only up to the amount of your winnings.
10. Plan Your Estate to Minimize Tax Impact
Appropriate estate planning will minimize the estate tax burden on heirs.
- Gifting Strategies: Regular gifting—a maximum of $17,000 to each heir—will over the years chip away at the value of your estate, thereby minimizing potential estate tax liability.
- Establishing Trusts: Trusts such as irrevocable life insurance trusts (ILITs) or generation-skipping trusts enable the transfer of wealth with no estate tax implications.
Conclusion
These strategies can allow you to have more income retention, but the tax lowering is quite complex and often changes. For this reason, relying on a qualified tax professional who understands your unique situation and can help you think through possible savings opportunities is prudent. Proactive planning and regular tax strategy reviews are meant to let you maximize any tax benefit available to lowering our legal liability.
