Each year, as tax season approaches, hard-working Americans search for ways to reduce their taxable income and lower their tax bill. Those in higher income brackets often feel particularly hard hit as a big tax bill can seem like a penalty for success. However, by working with us and your tax professional, it’s possible to implement strategies to minimize your overall tax liability and keep more money in your pocket for the things that matter most to you.
Here are six strategies you can discuss with us and your tax professional to reduce your taxable income and potentially lower your tax bill.
1. Make Contributions to Your Retirement Accounts
One of the most effective ways to reduce your taxable income is to contribute to a retirement account, such as a 401(k), 403(b), or a traditional IRA. The IRS increased contribution limits for 2023, so individuals can add up to $20,500 to their 401(k) and $6,000 to their traditional IRA. Those aged 50 and older can contribute an extra $7,500 in catch-up contributions to their employer-sponsored accounts and an additional $1,000 to IRAs.
By contributing to your retirement accounts, you may be able to deduct the amount on your federal income tax return, allowing the money to grow tax-free until retirement. With this strategy, you’re reducing your taxable income and incentivized to save more aggressively for retirement—a win-win.
2. Contribute to a Health Savings Account (HSA)
Another way to potentially reduce your taxable income is to contribute to a Health Savings Account (HSA). Contributions to an HSA lower taxable income, investment returns in an HSA investment account are tax-free, and funds used for qualified medical expenses can be withdrawn tax-free.
In 2023, the contribution limit for individual HSAs is $3,850, or $7,750 for family HSAs; if you are over 55, you can contribute an additional $1,000. Some employers don’t offer an HSA, but you can always start an account at your bank or another financial institution.
3. Save for College with a 529 Plan
A 529 plan is a powerful tool for reducing the taxes you pay over time, especially if you have children or plan to further your own education.
While contributions to these plans are not deductible on your federal income tax return, they offer a range of benefits that can help you save on taxes. For one, any investment earnings grow tax-free in a 529 plan, so you won’t be taxed on the money you earn through these investments. Additionally, when the money is withdrawn to pay for qualified education expenses such as tuition, room and board, books, and supplies, the funds are considered tax-free.
Strategically putting money aside for college can help you save significantly over the long term, especially if you expect substantial education expenses. However, it’s important to note that contributing to a 529 plan can have gift tax consequences, so it’s essential to consult a tax professional to ensure you’re making the most of this valuable savings vehicle while minimizing your tax liabilities.
4. Claim a Home Office Deduction
If you work from home as a freelancer, contractor, or business owner, you may be eligible for a home office deduction, whether you are a homeowner or a renter. Employees cannot claim it, but if you earn income on the side through self-employment, you may be eligible, even if you are not a full-time business owner.
To qualify for a home office deduction, a portion of your home must be dedicated to the exclusive use of conducting business regularly, and the home must also be your principal place of business. Deductions for a home office are based on the percentage of the home devoted to business use, specifically as indirect expenses. As determined by the IRS, a more simplified deduction method allows qualified taxpayers to deduct $5 per square foot for a maximum of 300 square feet or $1,500.
5. Make Generous Charitable Donations
Making charitable donations has long been a proven strategy for reducing your tax bill. To benefit from this approach, you must itemize your deductions, and your donation is subject to the limit of 50% of your adjusted gross income (AGI).
One technique to optimize your donations is to consider giving appreciated stock, which may enable you to avoid capital gains tax. Additionally, you may increase your basis for capital gains tax by including reinvested dividends, resulting in a higher cost basis and a reduced capital gain when you sell the investment later.
6. Track Your Medical Expenses
Keeping track of your medical expenses may help you save money and reduce your tax bill too. By deducting qualified medical expenses exceeding 7.5% of your adjusted gross income for the tax year, you can potentially lower your taxable income and reduce the taxes you owe.
Qualified medical expenses can include things like doctor’s visits, prescriptions, medical procedures, and medical equipment. By keeping careful records of your expenses and ensuring they qualify for the deduction, you may save a significant amount of money on your taxes. However, it’s important to note that not all medical expenses are deductible, so you will want to consult with a tax professional or carefully review the IRS guidelines to ensure you’re accurately calculating your deduction.
Use Tax Strategies to Your Benefit
Earning a high income doesn’t mean accepting a high tax liability. The laws are in place to protect taxpayers against paying more than necessary, but effectively reducing your taxable income and lowering your tax bill requires having specialized knowledge of the strategies available.
By contributing to retirement and health savings accounts, saving for college with a 529 plan, claiming a home office deduction, making charitable donations, and tracking medical expenses, it is possible to save on taxes. Consult with us to learn more about implementing these strategies and ensure we proactively seize tax-saving opportunities.
Kevin Stoddard is a LPL Financial Advisor with Stoddard Financial in Medfield, Massachusetts. Stoddard helps clients throughout New England to identify, plan, and execute strategies designed for securing their desired financial future. With their Financial Wellness @ Work program, they engage, educate, and empower employees by helping them to understand and appreciate the value of their benefits package.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. Wealth Advisors of Tampa Bay and LPL Financial do not offer tax advice or services.
Prior to investing in a 529 Plan, investors should consider whether the investor’s or designated beneficiary home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax-free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
This material was prepared by Crystal Marketing Solutions, LLC, and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate and is intended merely for educational purposes, not as advice.