Effective Ways Income Earners Can Lower Taxable Income

Paying taxes is necessary, but the truth is that it doesn't mean you have to give up more than needed. This is why, whether you're an employee, small business owner, or self-employed, there are different ways to lower taxable income.

It just takes some planning and the right tax deduction strategies. You can then reduce your taxable income and keep more of what you've earned.

If last tax season caught you off guard, now is a great time to plan for the next one. Knowing the right tax deduction strategies can help you reduce your taxable income. 

This article provides a guide to explain different tax deduction strategies that can help you reduce your taxable income. These methods can help you save money when it's time to file again.

What Are Taxable Incomes?

You can think of taxable income as the figure you earn that the government uses to determine how much tax you owe each year. It's your total income after you have removed every necessary deduction that you have. This includes your standard or itemized deductions.

Your taxable income can come from different places. It can be your regular job, that is, your wages, salaries, and tips. It can come from your side hustles, bonuses, rental properties, investments, or services you received as payment. Basically, if it's something that you earned from working, it's likely part of your taxable income.

One thing you need to do is to understand how your income taxes work. This is because it determines your tax bracket and the percentage that you'll be taxed at.

Tax Deduction Strategies To Lower Taxable Income

Here are some tax deduction strategies that can help lower taxable income for both employees and employers:

Maximize Your Tax Deductions

Tax deductions can reduce the part of your income that is normally supposed to be taxed. This includes common deductible income like mortgage interests, state or local taxes and medical expenses, among others. Therefore, by claiming them correctly, you can significantly reduce what you owe.

Note that not everyone can claim their deductible income. They can only be accessed by people who itemize their deductions. However, most people's standard deductions are usually more than their deductible income. Therefore, this method would be a good fit for you if you itemize your deductions.

Add to Your FSAs or HSAs 

The money you put into your FSAs and HSAs is not usually taxed. So you can basically save on federal income tax, Social Security, Medicare, and sometimes state taxes, too. When you use those funds to cover eligible medical expenses, you won't pay any taxes on them.

However, here's the thing for FSAs: if you have any unused money by the end of the year, you're going to lose that money. Therefore, you cannot move that amount over to the next year, unlike HSAs.

Pay Attention to Your Tax Credits

Tax credits actually make it easy to reduce the actual taxes you owe. What this means is that if you have a $1,000 tax credit, you will have the full $1,000 off your tax bill. This makes it better than a deduction. It not only lowers your taxable income but also reduces the taxes that you owe based on your tax rate. 

To understand it better, if you have a 12% tax bracket, a $8,000 deduction would reduce your tax bill by $960. However, if you have a particular tax credit, you still get that exact amount, where nothing is removed. For example, if you have a $1000 tax credit, your tax bill will be reduced by exactly $1000. This is regardless of your tax bracket

Keep Money for Retirement

Planning for the future can also help you save on taxes. Contributions to your retirement accounts can help lower taxable income now or even provide tax-free income later. This, however, depends on the type of retirement account that you have, some of which are:

• Traditional IRAs and 401(k)s: Contributions to these retirement accounts are usually made before taxes. This means that you are able to reduce your taxable income for the year you contribute. You can then pay taxes later when you withdraw the money in retirement.

• Roth IRAs: Contributions are after-tax, but when you retire, you won't owe taxes on your withdrawals.

Donate to Charity

Charitable donations can also help to reduce your taxable income if you itemize. It can be giving out cash, clothes, or appreciated assets like stocks or property to lower your tax bill. Also, when you give out valuable things, you may not have to pay taxes on capital gains.

Make sure that the organization you're giving to is IRS-approved. If it looks like a scam, it can waste your money and then disqualify your deductions.

Shift Your Income Strategically

As a business owner or self-employed individual, this strategy can actually help legally when it’s done correctly. This usually means allowing someone who is in a lower tax bracket to pay instead of you. It can be your family member, so your income can be taxed at a lower rate.

For example, you can hire your child, or basically someone close to you, to work in your business. So, as long as they're actually doing real work, you can pay them wages. Then, instead of you lowering your taxes, you’ll lower theirs instead.

Another way to shift income is by deferring some of your earnings until the next calendar year. This especially helps if you expect to fall into a lower tax bracket later.

Start a 529 College Fund For Your Children

A 529 savings plan lets you invest money for school costs. This includes expenses from kindergarten to college. Your contributions won't cut your federal taxable income. However, they might reduce your state taxes. What's even better is that your investment grows tax-free, and you won't pay any taxes on the money you take out. This is as long as it's used for eligible education costs.

Some 529 plans let you lock in tuition prices at certain public universities. This is done through prepaid tuition programs. This means even if college costs increase in the future, you're still covered. It is a great option if you're planning long-term and still want to save money.

Offload Your Investments that Aren't Working

If you have a stock or asset that is losing value, it may be time to sell it off. Selling investments that have dropped in value can actually work in your favor. This is called tax-loss harvesting. This strategy helps you use report losses to lower your taxable income.

Let's say you sold one investment for $2,000 more than you bought it. You then sell another one for $2,000 less. Since they cancel each other out, you don't owe any capital gains tax.

Deduct Medical Expenses

You can reduce your taxable income by deducting medical expenses on your taxes if you itemize. You can decide to claim qualified medical and dental costs that exceed 7.5% of your adjusted gross income.

Your medical expenses cover surgeries, doctor visits, prescriptions, and mental health services. It may even include certain travel costs that are related to medical care. You can deduct these costs in the year you pay them. This doesn’t have to be the year you got the service.

In Summary

Reducing your taxable income is mostly about making good choices that support your financial goals. Even with these strategies, it still doesn't mean that you cannot make mistakes. When you plan your taxes, one mistake can lead to penalties or surprise bills from the IRS. This is something you don't want to look forward to. This is why it is a good idea to work with a tax professional. They'll help make it easier to explain these methods while also making the work easy for you. 

If you're planning to file your taxes, you absolutely need accurate income documentation. Our simple pay stub generator lets you make professional pay stubs in just minutes. It makes it easy to help you track your deductions and stay organized when it's tax season. Generate your pay stubs with us now!