4 Ways to Lower Your Taxable Income (and Save on Taxes)

5 min read|Mar 15, 2022|fbtwitteremail

The income you earn doesn’t = the amount you’re taxed on. And lowering your total earnings could give you a break on how much you pay.

Wait. Are you saying I should earn less to lower my tax bill?

Not at all. 

There’s your gross income, which includes all of your income. And then there’s your adjusted gross income. Which takes into account all of the things you contribute to (think: retirement) to lower your taxable income. 

Since you pay taxes based on your adjusted gross income, lowering your taxable income could mean a smaller tax bill. 

Got it. So how do I lower my taxable income?

By contributing to certain tax-advantaged accounts. Some are designed to encourage people to save for their future selves by offering them tax breaks now. 

Here’s how to take advantage of them to reduce what you owe to the IRS… 

Traditional 401(k)

Have access to a traditional 401(k) at work? If so, it could help you both now and later. 

When you contribute to a traditional 401(k), you take money that would usually go toward your income and divert it into your retirement savings. With a traditional 401(k), that money isn’t taxed now (unlike a Roth 401(k)), which means it isn’t part of your taxable income. (Hint: You’ll pay taxes on it later when you take it out in retirement.) 

So contributing to your workplace’s traditional 401(k) now could help you lower your taxable income while helping you build up some savings for later on. And you might even get free money while you’re at it. Reminder: Check to see if your employer matches 401(k) contributions. That’s a win-win-win. 

Psst… this only works for the traditional 401(k) plan, not a Roth 401(k), which your employer might also offer.

How much can I contribute? In 2021, $19,500. In 2022, $20,500. Plus a $6,500 “catch-up” contribution for anyone over 50.

Who qualifies? Anyone whose employer offers an account. 

When can you withdraw without penalties? At age 59 and a half. Or with a hardship withdrawal

When can you contribute for the year? Only during the calendar year.

Simplified Employee Pension Plan (SEP IRA)

If you’ve joined the ranks of the 401(k)-less self-employed, there’s still an option for you. A SEP IRA can help you lower your taxable income, as the contributions are deducted from your income.

How much can I contribute? Up to 25% of your compensation, or $61,000 in 2022 (or $58,000 in 2021), whichever is lower. 

Who qualifies? Any employer, including self-employed individuals, can start one.

When can you withdraw without penalties? At age 59 and a half.

When can you contribute for the year? The whole calendar year, and then usually until the due date for filing your federal income tax forms. 

Traditional Individual Retirement Account (IRA)

IRAs come in two flavors: Roth and traditional. To lower your taxable income with an IRA, you’ll need a traditional IRA. With this type, you pay taxes later (in retirement) and get the tax benefit now.

For 2021 and 2022, you can contribute and deduct up to $6,000, as long as you don’t exceed the deduction limit. Which is $78,000 for a single person or $129,000 for married couples. (Note: This is only if you have a retirement plan at work. If not, the rules are different.) And you could shave some off your taxable income with this hack. Oh, and earmark some cash for retirement. Nice. 

Psst… like with 401(k)s, this doesn’t work for the Roth version of this account.

How much can I contribute? Up to $6,000 in 2021 and 2022, plus a $1,000 “catch up” contribution if you’re over age 50.

Who qualifies? Anyone with earned income for the year.

When can you withdraw without penalties? Age 59 and a half. 

When can you contribute for the year? The whole calendar year, and then usually until the due date for filing your federal income tax forms.

Health Savings Account (HSA)

This account is triple-tax advantaged. Money goes in pre-tax, comes out tax-free, and grows tax-free. And yes, it will lower your taxable income. 

And, if you’re wondering how you’ll ever use this money, it can be invested within the account for future healthcare expenses. Read: They don’t expire (not to be confused with an FSA). They’ll even last until retirement.

How much can I contribute? You can contribute up to $3,650 for a single person in 2022, and $7,300 for a family insurance plan. Plus, $1,000 extra in catch-up contributions for anyone over the age of 55.

Who qualifies? Anyone with a high-deductible healthcare plan.

When can you withdraw without penalties? Anytime you have eligible healthcare expenses. Or after age 65 when you can spend it like a retirement account.

When can you contribute? Until April 15, 2022, for 2021 contributions.

And the IRS will handle the rest?

No, you will at tax time.

Most of these accounts have tax forms associated with them, and they’ll get sent to both the IRS and you before tax time. When you do your taxes, you’ll figure out your adjusted gross income, which is your gross income minus everything that lowers your taxable income.

Note: Because the IRS sees things like retirement contributions or HSA expenses as “above the line” deductions, you can either claim the standard deduction or itemize deductions to try to further reduce what you owe to the IRS. 

Anything else I can do to lower my taxable income?

You have a few other options:

  • Tax-loss harvesting. Aka selling stocks that lost value throughout the year could lower your taxable income by up to $3,000 (or $1,500 for those who are married but filing separately).

  • Donating to charity. Thanks to the CARES Act, people who don’t itemize their deductions are able to take an extra $600 of charitable cash donations made to qualifying organizations off their taxable income. 

  • Paying interest on mortgages and/or student loans could also lower your taxable income. (But…this won’t apply for federal student loan holders for 2021 as no interest is due because they’re on pause with interest rates suspended.)

theSkimm

Less income = a lower tax bill. It’s possible to lower your total taxable income with retirement contributions, an HSA, and even donating to charity. 

Skimm'd by Liz Knueven, Kamaron McNair, Stacy Rapacon, and Megan Beauchamp