As Benjamin Franklin once said, “in this world, nothing is certain, except death and taxes.” We’ve all heard that adage before. Paying taxes is inevitable, but there are numerous legal ways to reduce your tax bill.
You can maximize your savings by utilizing a number of tax deductions, credits, and strategic planning to retain a larger portion of your earnings. In this blog, we’ll explore five effective methods to help you reduce your tax burden while staying compliant with the IRS.
1. Maximize your retirement contributions
Contributing to a retirement account is one of the most efficient ways to reduce your taxable income. When you contribute to a traditional 401(k) account, an IRA, or another tax-advantaged retirement plan, you can lower your taxable income for the year. This has the added benefit of providing significant tax savings.
According to a recent poll, over 40% of Americans don’t know what a 401(k) is, which means they are missing out on both tax savings and employer-matching funds.
For the 2024 tax year, the contribution limit for 401(k) plans has increased to $23,000, up from $22,500 in 2023. Those aged 50 or older can contribute an additional $7,500 as a catch-up contribution. Maximizing these contributions reduces your taxable income directly, which could lower your tax bracket and result in substantial savings on your tax bill.
Moreover, contributions to a traditional IRA can reduce your taxable income by up to $6,500 for individuals under 50, or $7,500 for those 50 and older.
2. Take advantage of tax credits
Tax credits can provide significant savings by directly reducing the amount of taxes you owe. Unlike deductions, which lower your taxable income, credits reduce your overall tax liability dollar for dollar. There are many valuable credits available, including the Earned Income Tax Credit (EITC), Child Tax Credit, and education-related credits.
The Earned Income Tax Credit is particularly beneficial for lower-income earners. Recent IRS data from 2023 shows that 23 million taxpayers claimed the EITC, with an average credit of $2,541 per return. The Child Tax Credit also provides a substantial benefit, offering up to $2,000 per qualifying child.
For 2024, taxpayers can take advantage of an increased American Opportunity Tax Credit (AOTC) for educational expenses, providing up to $2,500 for eligible students.
Also, don’t forget that the Inflation Reduction Act of 2022 extended and expanded federal tax credits for energy efficiency updates—$3,200 annually for installing heat pumps, energy-efficient windows and doors, insulation and similar upgrades, to American homes and businesses.
3. Claim deductions for charitable contributions
Donating to qualified charitable organizations is a great way to reduce your tax liability while supporting causes you care about. Contributions made to 501(c)(3) organizations are tax-deductible, and in some cases, you can deduct up to 60% of your adjusted gross income (AGI) in charitable donations.
According to Giving USA’s 2023 report, charitable donations in the U.S. totaled $484.85 billion in 2022, with individual giving making up 67% of that total.
However, many taxpayers fail to claim the full value of their charitable contributions. To secure the highest possible deduction, keep detailed records of your donations, including receipts and acknowledgments from the organizations.
For non-cash donations such as clothing or household items, ensure that the value is accurately assessed, as the IRS may require additional documentation for items valued over $500.
4. Use tax-efficient investments
Investing wisely can help you grow your wealth while minimizing your tax liability. One way to do this is by taking advantage of tax-efficient investment vehicles like Health Savings Accounts (HSAs) and Roth IRAs. HSAs offer a triple tax advantage in that contributions are tax-deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are tax-free.
For 2024, the IRS has raised the contribution limits for HSAs to $4,150 for individuals and $8,300 for families. This allows you to reduce your taxable income while saving for future medical costs. Additionally, Roth IRAs provide tax-free growth on investments, and qualified withdrawals in retirement are tax-free.
While Roth IRA contributions don’t reduce your taxable income today, the long-term benefits of tax-free growth can be substantial, especially for younger investors.
Investors should also consider tax-efficient funds that focus on minimizing capital gains, thereby reducing the taxes owed on investment income.
These might take the form of mutual funds or exchange-traded funds (ETFs), and apply strategies like low turnover and tax-loss harvesting within the fund. Be aware that index funds typically have lower turnover and generate fewer capital gains. ETFs are often more tax-efficient than mutual funds because of their structure and redemption process.
5. Plan for itemized deductions
Many taxpayers automatically take the standard deduction, but for those with substantial qualifying expenses, itemizing deductions can lead to significant tax savings. In 2023, the standard deduction was $13,850 for individuals and $27,700 for married couples filing jointly. However, if your deductible expenses exceed these amounts, itemizing may be the better option.
Common itemized deductions include mortgage interest, state and local taxes (SALT), medical expenses, and charitable contributions. The IRS allows taxpayers to deduct medical expenses that exceed 7.5% of their AGI.
U.S. healthcare spending now stands at $13,493 per person. It makes perfect sense that this deduction would be helpful to individuals with high healthcare expenses.
If you have significant property taxes, mortgage interest, or other qualifying expenses, taking the time to itemize your deductions could lead to a lower tax bill. Be sure to keep accurate records and consult with a tax professional to ensure that itemizing is worth it for your situation.
The right tax professional can make all the difference
Reducing your tax bill on earnings requires careful planning and an understanding of the available deductions, credits, and strategies. You can lower the amount of taxes you owe legally through:
- Maximizing your retirement contributions
- Taking advantage of tax credits.
- Donating to charity.
- Using tax-efficient investments such as HSAs
- Planning for itemized deductions
Remember, wealth management doesn’t have to be super complicated. Count on David’s Family CPA to help you make the most of these opportunities and keep more of your income in your pocket. We help you manage your money, so you can concentrate on your day-to-day business.