Taxes and death are the only two guarantees of life. While you cannot avoid death, you can reduce or avoid some tax liability. If you want to reduce your taxable income, credits, deductions and investment strategies are available for individuals, solopreneurs and small businesses.
The government routinely changes tax codes, as do the ways to reduce your tax liabilities. There are a few methods, however, that have been around for years that we recommend considering now.
Retirement Account Contributions
Retirement account contributions are a win-win for taxpayers. Not only is it a way to reduce your taxable income, but they help prepare you for future retirement. 401(k) and IRA account pre-tax contributions are deducted from your income, reducing the total amount of federal tax owed. The invested funds grow in your retirement account until you are ready and are within retirement age to make withdrawals.
If you need the extra deduction in this year’s tax filing, no problem. You can contribute to your traditional IRA up until the tax-filing deadline.
Flex Spending Accounts
Medical expenses can add up, especially if you have a high-deductible health plan. Flex Spending Accounts allow you to allocate pre-tax dollars toward future medical expenses and costs throughout the year. Expenses include copays, medicine, de cleanings and more. FSAs are a popular employee benefit available for the employee and their dependents.
There are limitations to what you can deposit and rules around the time frame you must use the funds. When managed correctly, FSAs can reduce your taxable income and provide the financial security to cover medical costs throughout the year.
Health Savings Account
HSAs are similar to flex spending accounts in that they offer an opportunity to set aside pre-tax dollars into an account established to offset the costs of qualified medical expenses. Using an HSA will reduce your taxable income and your tax liabilities. Unlike an FSA, Health Spending Accounts can roll over from year to year if gone unused.
Side Hustle Business Deductions
The gig economy saw tremendous growth during the Covid-19 pandemic, allowing people from all over the country to sell their products, services and skills to earn extra money. These side hustles provide extra cash and tax deductions too. Depending on your business and how you structured your self-employed entity, you can deduct numerous costs such as business-related travel, marketing expenses, trade publications, software and technology, dues and office supplies.
While there are rules to what you can deduct based on your usage, our Tax Time team can help you uncover the opportunities to reduce your annual taxable income with self-employment deductions.
Accelerated Depreciation
Small business owners eventually require equipment and property to help run the business. High-dollar purchases like computers and printers provide you with years of tax deductions through accelerated depreciation. Based on the expected lifespan of the product or property purchased, businesses can either deduct 100% of the costs in a single year, or depreciate it over several years. You will want to consider your taxable income this year versus your anticipated future earnings to decide which is right for you.
Entity Evaluation
Some business entities are pass-through, meaning the owner files the business revenue on their individual return. Depending on the earned income level, business owners can reduce their taxable income by filing with the IRS as an S-corp. S corporations allow business owners to collect both business distributions and a salary. Unlike traditional wages, business distributions are not subject to payroll tax, so the offset can help. Before considering this route, give us a call and let us help you understand the pros and cons of each entity structure so you can make the right choice for you.
Higher Education Credits
Several tax credits are available to families and individuals who pursue higher education. The American Opportunity tax credit provides up to $2,500 per student annually and is claimable for the first four years of college. The deduction can undoubtedly help reduce your taxable income.
The Lifetime Learning Credit is available for adults seeking additional education and training. It provides up to a $2,000 credit per year toward education that improves your specific job skills. This is a great way to reduce your tax burden and improve your earning potential.
529 Savings Plan
Ever heard of a 529 college savings plan? A 529 allows you to contribute post-tax dollars to a savings account dedicated to secondary education. They are eligible for use in colleges, vocational and trade schools. Not only do 529s grow in value, much like a retirement IRA or 401(k), the withdrawals are tax-exempt when used for qualifying educational expenses.
If you have children or plan to go back to school yourself, open a 529 plan for college savings. Moreover, withdrawals from accounts are tax-exempt when used for qualified education. If your child doesn’t go to school or doesn’t need all the money, you can assign it to another beneficiary or use up to $10,000 to repay student loans. If secondary education isn’t in your future, don’t worry. In 2023, the government allowed 529 account owners to convert some unused funds into a Roth retirement account.
While 529 savings plan contributions are not deductible from your federal taxes, you may qualify to deduct 529 contributions from your state income tax. Their benefits are tremendous and worth looking into.
Itemize State Sales Tax
Taxpayers with itemized deductions can include either their state income tax or state sales tax on a Schedule A . If you live in a state, such as Texas or Florida, where state income tax isn’t collected, the state sales tax is a great option to reduce your federal tax liability. Major purchases like cars or boats have high sales tax requirements that may qualify for a federal tax deduction.
Charitable Donations
Charitable donations are not only a kind and generous thing to do but also tax deductible. Payroll deductions, money and donations of goods are deductible.
Another great way for high-income earners to reduce their tax liability is to establish a donor-advised fund where contributions to these funds are deductible in the year they made but are eligible for distribution over many years.
Capital Gains Tax Adjustments
If you sell your house, you may get stuck owning capital gains tax, especially if your property’s value has grown significantly. Single taxpayers can exempt up to $250,000 of their home’s appreciation from the capital gains tax, and married couples get a $500,000 exemption. The IRS will only let you claim this once every two years, but you can also reduce your tax liability for making home improvements.
Military Member Deductions
If you are in the military and must travel for work or assume costs associated with moving, you likely have eligible deductions. Unreimbursed costs and travel expenses required for military-associated purposes are eligible for deductions and can reduce your taxable income.
Also, the wages you earn while on deployment to combat zones will remain untaxed. Some military reenlistment bonuses are also tax-free when the reenlistment occurs in a designated combat zone located overseas.
If you are in the military, give us a call and we can step you through the various tax deductions and credits you qualify for throughout your year of service.
Energy Efficiency Upgrades
The Inflation Reduction Act of 2022 expanded federal tax credits for energy efficiency updates to homes and businesses. Through 2032, homeowners can claim up to $3,200 each year in credits for specific energy-efficiency property improvements. Upgrading your windows, doors, water heater and appliances not only helps you earn the tax credit but help you save money on utility costs, too.
Additional credits are available to businesses and homeowners who install solar panels, wind energy and geothermal systems.
Consider State Tax Breaks
Most states also collect income taxes and provide tax breaks as well. Remember, these deductions may also help offset what you owe to the state where you reside. Regardless of where you live, check with your local and state taxing authorities to see the available deductions.
Discover How to Reduce Your Taxable Income
If you want to explore additional ways in which you can reduce your taxable income, give us a call. Our Tax Time CPAs specialize in helping small business owners identify areas to save money, reduce tax liabilities and take control over their financial freedom.