If you’re looking to reduce the amount of income tax you’ll need to pay, there are numerous strategies to consider. Familiar moves include contributing to tax deferred retirement and health-spending accounts, deducting certain taxes and interest, and making charitable donations. More complex maneuvers include timing investments to offset gains with losses.
Because each person’s situation is unique, be sure to check with your tax accountant to find out how a potential strategy might work for you. Note that some of the strategies included in this guide have income limits.
Keep reading to see how many of these 25 tactics you can implement.
25 Ways to Lower Your Taxable Income
As you look through this list of 25 ideas on how to pay less in taxes, you’ll note that some are broad, advising how to reduce either W2 taxable income or self-employment income. Meanwhile, others are more targeted — for instance, applying only to the self-employed. Keep track of ideas that pertain to your situation, so you can explore them further.
1. Contribute to a Retirement Account
Many IRA contributions are tax deductible. If you’re covered by a plan at work, you can contribute up to $20,500 to a 401(k) plan in 2022, and an additional $6,500 if you’re over 50. You can also contribute $6,000 to an IRA ($7,000 if you’re over 50), though your deduction may be limited depending on income and other factors.
Self-employed individuals can contribute between 25% and 100% of net earnings from self-employment, up to $61,000 for 2022. Plans available to the self-employed include the Simplified Employee Pension (SEP) plan, solo-401(k), and Savings Incentive Match Plan for Employees (SIMPLE IRA).
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2. Open a Health Savings Account
A health savings account (HSA) allows you to deposit money on a pre-tax basis. Contribution limits depend on your health plan, age, and other factors, but most individuals can contribute $3,650 for 2022.
Funds can be used to pay for qualified medical expenses or rolled over year to year. You must have a high deductible health plan (HDHP) to contribute to an HSA.
3. Check for Flexible Spending Accounts at Work
In lieu of an HSA, you can contribute up to $2,850 in pre-tax dollars to a flexible spending account (FSA). FSAs allow people with a health plan at work to deposit money and then use it to pay for qualifying health care costs. Unlike HSAs, FSAs don’t require an HDHP to qualify. The downside: Only a small portion of funds may be rolled over to the following year.
4. Business Tax Deductions
The IRS guidelines around business deductions change frequently, so it’s wise to watch out for their announcements throughout the year. In 2022, there’s an enhanced meal deduction and updates to the home office deduction (described next). Some business expenses apply only to self-employed people.
5. Home Office Deduction
When a self-employed person regularly uses a specific area of their home for business purposes, they may qualify to deduct costs associated with that part of the house. The home office deduction can be calculated in two ways (regular or simplified) up to the current gross income limitation. For more information, search for “IRS publication 587.”
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6. Rent Out Your Home for Business Meetings
If you’re self-employed, you can also rent out your home for business events and meetings, collect the income — and not have to pay income taxes on that rental income. To learn specifics, visit https://www.irs.gov/pub/irs-drop/rp-13-13.pdf.
7. Write Off Business Travel Expenses
Travel expenses, as defined by the IRS, are the “ordinary and necessary expenses of traveling away from home for your business, profession, or job. You can’t deduct expenses that are lavish or extravagant, or that are for personal purposes.” For IRS guidance for both W-2 employees and the self-employed, go to https://www.irs.gov/taxtopics/tc511.
8. Deduct Half of Your Self-Employment Taxes
When calculating your adjusted gross income (AGI) as a self-employed person, using Form 1040 or Form 1040-SR, you can deduct half the amount of your self-employment tax. The 2022 self-employment tax rate is 12.4% for Social Security and 2.9% for Medicare, based on your net earnings.
9. Get a Credit for Higher Education
This tax credit can go up to $2,500 based on tuition costs along with what you paid in certain fees and for course materials. As a first step, income tax owed is reduced dollar for dollar up to your limit. Then, if your tax credit is more than what you owe, you may be able to get up to $1,000 in a refund.
10. Itemize State Sales Tax
Currently, you can deduct a total of $10,000 for itemized state and local income taxes, sales taxes, and property taxes when you use Form 1040 or 1040-SR. If married but filing separately, the total is $5,000 per person. The IRS provides a calculator that you can use to figure out your deduction at https://apps.irs.gov/app/stdc/.
11. Make Charitable Donations
A taxpayer can typically deduct up to 60% of their AGI to qualified charities. But starting with contributions made in 2020, the IRS implemented a temporary suspension on limits. This means that a person can make qualified charitable contributions up to 100% of their AGI.
12. Adjust Your Basis for Capital Gains Tax
If you sell an asset, including but not limited to investments, a capital gains tax is levied on the difference between the purchase price and what it sells for. The adjusted basis also takes into account the costs of capital improvements made, minus decreases such as casualty losses. For more on the topic when selling a home, search for “IRS publication 523.”
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13. Avoid Capital Gains Tax by Donating Stock
You may be able to avoid paying capital gains tax if you transfer the ownership of your appreciated stock (held for more than one year). This is something that needs to be handled in exactly the right way; your tax accountant can help.
14. Invest in Qualified Opportunity Funds
If you invest in property through a Qualified Opportunity Fund, the IRS states that you can temporarily defer paying taxes on the gains. Taxes can be deferred (not reduced or canceled) up until December 31, 2026, or until an inclusion event occurs earlier than that date. This is a complex strategy and, again, you may want to get professional advice.
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15. Claim Deductions for Military Members
You may be able to deduct moving expenses if you’re a member of the military on active duty who relocated because of a military order and permanent change of location. In this case, you can potentially deduct your unreimbursed moving expenses as well as those for your spouse and dependents. You can calculate relevant expenses on “IRS form 3903, Moving Expenses.”
16. Enroll in an Employee Stock Purchasing Program
In an employee stock purchase plan (ESPP), an employee who works at a company that offers this program can buy company stock at a discount. The company takes out money through payroll deductions and, on the designated purchase date, buys stock for participating employees. Note that only qualified plans have potential tax benefits.
17. Deduct the Student Loan Interest You’ve Paid
You may qualify to deduct student loan interest. Annual deduction amounts are the lesser between the amount of interest paid and $2,500. This deduction is lowered and eliminated when your modified adjusted gross income (MAGI) reaches a certain limit based on your filing status.
18. Sell Your Losing Stocks to Claim Capital Loss Carryover
If you sell stock at less than the purchase price, you’ve experienced a capital loss. You can use that loss to offset any capital gains that year. If you’ve lost more than you’ve gained, this can reduce your taxable income, which could reduce what you owe up to $3,000 for individuals and married couples, and $1,500 for someone married who filed separately.
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19. Deduct Mortgage Interest
You can deduct the money you paid on mortgage interest on the first $750,000 (or $375,000 if married, filing separately) of mortgage debt you owe. Higher limits exist ($1,000,000/$500,000) if the debt was taken on before December 16, 2017.
20. Deduct Medical Expenses
Under certain circumstances, you can deduct medical and dental expenses for yourself, your spouse, and dependents. You’ll need to itemize on your tax return and can only deduct qualifying expenses that exceed 7.5% of your AGI.
21. Delay IRA Withdrawal Upon Retirement
You can delay IRA withdrawals so that you don’t have more taxable income when you’re a high earner. For example, if you reach the age of 70 ½ in 2020 or later, you can wait until April 1 after you reach the age of 72.
22. Ask Your Employer to Defer Income
You pay income tax in the year the income is received. Although there are reasons why employers typically can’t postpone providing paychecks, they may be able to delay a bonus to the following year as long as this is standard practice for them. If self-employed, you can delay sending your end-of-year invoices to bump December payments to the following calendar year.
23. Open a 529 Plan for Education
A 529 plan allows you to save for future educational expenses. Although the contributions themselves aren’t deductible, interest that accrues in the account is tax-free, federally, as well as being tax-free in many states. In other words, when the money is withdrawn to pay college expenses, it is not taxed.
24. Buy Tax-Exempt Bonds
Interest you receive on muni bonds, for example, is not federally taxed (although there may be state and/or local taxes). These are typically very safe investments, although the interest rates may not be what you want.
25. Time Your Investment Gains or Losses
Known as tax loss harvesting, this strategy takes planning because you’ll want to ensure that any investment gains can be offset, as much as possible, by tax losses. So you may decide, as just one example, to hold on to a stock that’s lost significant value — selling it at a time when it can offset a stock sale with a sizable gain.
High earners looking to reduce taxable income have many avenues to explore — some you’ve likely heard of, with others perhaps new to you. For instance, investors may be able to take advantage of tax loss harvesting, tax loss carryover, or tax efficient investing. Explore strategies of interest with the SoFi Insights free budgeting app, and consult your tax accountant about your specific situation.
To take advantage of tax reduction opportunities, it’s important to keep careful track of your financial transactions. The SoFi Insights money tracker app can help track all of your money, all in one place. You’ll benefit from spending breakdowns, financial insights, and more.
How can I lower my taxable income?
If you’re wondering how to reduce your taxable income, there are numerous strategies that might work for your situation. A good place to start: Contribute to a retirement account, open a health savings account, and learn which taxes and interest you can deduct. Talk to your tax accountant about specific questions you may have.
What are the tax loopholes for the rich?
If you’re looking to reduce your taxable income, consider making charitable donations and investigating investment strategies that offset gains with losses.
Do 401(k) contributions reduce taxable income?
Said another way, are IRA contributions tax deductible? Retirements typically offer some tax benefits with specifics varying based on the type of retirement account. Traditional IRAs have different rules, for example, than Roth IRAs.
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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.