All taxpayers have one thing in common- they all want to lower the amount of taxes they owe every year. In fact, how to lower taxes is one of the most common financial planning concerns among individuals and business owners.
Our tax experts at Waters Hardy have heard this concern many times over the years and we have made it our business to master all aspects of tax planning and compliance. We can assure you that we provide different options to legally lower your taxes, including smart ways to lower your taxable income.
What is Taxable Income?
For each dollar you earn from your employer, you must pay a certain amount in taxes based on your level of income and where you live. Taxable income is the portion of your gross income used to calculate how much tax you owe in a given tax year. It’s basically your income minus allowable deductions.
Taxable income includes wages, salaries, bonuses, and tips. Additionally, investment income and various types of unearned income qualify as taxable income, as well. There are many legal ways to lower your overall taxable income to minimize your tax bill, without taking a pay cut.
Smart Ways to Lower Taxable Income and Lower Taxes
1) Contribute to Retirement Savings
When you make contributions to your 401(k), you do it on a pretax basis. Essentially, some of the money earned through your work goes directly into the account before taxes are taken out of it. That reduction from your take-home pay lowers your taxable income. As a result, you pay less income tax.
Each year, you can contribute to an IRA a total of $6,000, or $7,000 if you’re 50 or older. Contributions to a traditional IRA are generally deducted from your taxable income immediately. The investments in your account grow tax-free until you start making withdrawals after you turn 59 ½, when you’ll owe income taxes on distributions.
2) Contribute to Flexible Spending or Health Savings Accounts
- FSA (Flexible Spending Account)
The IRS lets you move tax-free dollars directly from your paycheck into your FSA to use during the calendar year for medical, dental, and some related expenses for yourself and your qualified dependents.
- In 2022, the limit was raised to $2,850.
- In the past, all money designated to FSA had a use-it or lose-it policy that must’ve been used by the end of the year. As part of the Consolidated Appropriations Act, employers can allow employees to carry over all unused funds from 2021 to 2022. Otherwise, they can extend the grace period from 2.5 months to 12 months.
- HSA (Health Savings Account)
If you have a high-deductible health care plan, you may be able to lower your tax bill by contributing to a health savings account, which is a tax-exempt account you can use to pay medical expenses.
- Contributions to a HSA are tax-deductible, and the withdrawals are tax-free, too, so long as you use them for qualified medical expenses.
- For 2022, the individual coverage contribution limit is $3,650.
- If you have high-deductible family coverage, the contribution limit is $7,300 for 2022.
- If you’re 55 or older, you can put an extra $1,000 in your HSA.
- It’s worth noting that your employer may offer an HSA, but you can also start your own account at a bank or other financial institution.
3) Donate to Charity
Over the last two years, the pandemic has particularly affected those in need. Many charities are struggling as donations remain down. As a result of the Taxpayer Certainty and Disaster Tax Relief Act of 2020 and the Coronavirus Aid, Relief, and Economic Security (CARES) Act, special changes in the law impacting charitable contributions and deductions remain in effect for the 2021 federal tax returns.
Under the temporary law, taxpayers don’t need to itemize deductions on their tax returns to take advantage of this. However, it creates tax-favorable donation options not normally available to about 90 percent of tax filers. The deduction lowers both adjusted gross income and taxable income, and that translates into tax savings for those making donations to qualifying tax-exempt organizations.
There are three major changes that were impacted by these temporary acts.
- Deductions for Individual Charitable Cash Donations up to $600.
- Corporate Deduction Limit Increased
- Business Deductions for Food Donations
There are many special circumstances to consider since not every charitable donation qualifies in the same way. So, it’s wise to seek the help from our professional tax experts at Waters Hardy, as we are able to guide you through the process so that you see the greatest return possible for your charitable contributions.
4) Sell Bad Stocks
Stock investments can either make money (capital gain) or lose money (capital loss). If your stock investment capital losses exceed your gains, you have a net loss. The IRS allows you to deduct a capital loss from stock or other investment that has lost money from your taxable income. Your claimed capital losses will lower your taxable income and reduce your tax liability.
The IRS limits your net capital loss in any tax year to $3,000. Any unused capital losses do not expire and are rolled over to future years.
Be aware though, you should sell a stock only if you need to and not sell just to avoid taxes. If you buy back the stock you sold within 30 days, your deduction will be withdrawn.
Start Lowering Your Taxable Income in 2022 Now
There are many factors and rules that affect your tax situation, and it’s important to have the help of experts with all of your tax prep needs. We know exactly what to look for and what to consider when lowering your taxable income.
Our team at Waters Hardy can not only help you determine the best way to lower your tax bill, but we can also help you figure out what your expected tax bill might be. This way, you can plan for a better financial future. Tax season will be over before you know it! If you haven’t filed your taxes already, now is the time to contact us to expedite this process before the April deadline.