4 Tips to Help Lower Your Taxable Income
Strategic tax planning is an important component of any comprehensive financial plan. Taking steps to lower your taxable income can help maximize the assets available to put toward achieving your long-term financial goals. Because high-income earners are typically required to pay a higher percentage of their income in taxes, it’s especially important to take steps to reduce your tax liability as much as possible. The following tips can help.
#1 – Understand what income tax bracket you typically fall into.
The first step in lowering your taxable income is to understand what income tax bracket you would fall into without any tax planning strategies in place. As a refresher, the United States uses a progressive tax system, which means that the percentage of income taxed increases as an individual’s income grows, as indicated in the following table.
#2 – Donate to charity.
Giving to charity is a great way to support the causes that matter most to you while also lowering your taxable income. The following charitable giving strategies can help maximize your tax deduction:
- Donate appreciated assets. Rather than donating cash to your favorite charitable organization, consider making an in-kind donation of appreciated securities. Directly transferring appreciated securities to a charity allows you to avoid triggering a taxable asset sale. Because charitable organizations are tax-exempt, the charity can then sell the security without paying taxes on the transaction. As a result, you can claim the full market value as a tax deduction, and the charity can receive a larger donation than if you had sold the security, paid taxes and donated the remainder.
- Consider a qualified charitable distribution (QCD). If you’re over age 70 1/2 and taking required minimum distributions (RMDs) from your qualified retirement plans, you can lower your taxable income by donating a portion of your RMD directly to a charity as a QCD. When transferred directly to a charitable organization, the QCD amount satisfies your RMD while being excluded from your taxable income.
- Use a donor-advised fund. A donor-advised fund allows you to make irrevocable charitable donations during a year in which your income is higher than normal, then distribute those donations to the charities of your choice over subsequent years. This can be an effective way to lower your taxable income in a single year while supporting charitable causes over time.
#3 – Max out your tax-advantaged savings.
As a high-income earner, consider maxing out any tax-deferred savings accounts available to you, including qualified retirement plans (401ks, 403bs, traditional IRAs, etc.), as well as your health savings account (HSA). Doing so can help reduce your taxable income while also allowing you to set aside additional funds for the future.
In 2024, you can contribute up to $23,000 to a qualified employer-sponsored retirement plan, with an additional $7,500 catch-up contribution allowed for those age 50 and older. The 2024 maximum HSA contribution amount is $4,150 for individuals or $8,300 for families, plus an additional $1,000 catch-up contribution for those age 55 and older.
#4 – Harvest investment losses to offset gains.
Tax-loss harvesting refers to the strategy of using realized investment losses to offset gains within your portfolio, which can help reduce your overall tax exposure.
Tax-loss harvesting works by selling an investment that has declined in value in the short term, a common occurrence in a heavily weighted equity portfolio, and replacing the investment with a highly correlated alternative. If done correctly, your risk profile and rate of return remain unchanged, but the temporary tax losses are extracted in the transaction.
By realizing the investment loss, a tax deduction is generated that can lower your taxes. You can then reinvest your tax savings to further grow the value of your portfolio.
