» 5 Ways to Reduce Taxable Income and Keep More Money in Your Pocket

Paying taxes is an unavoidable part of life, but there are legitimate strategies to help you reduce your taxable income, and in turn, keep more of your hard-earned money.

Understanding the tax system and knowing how to apply legal deductions, credits, and other financial maneuvers can have a significant impact on your finances.

Here are five effective ways to reduce your taxable income and keep more money in your pocket.

1. Maximize Retirement Contributions

One of the most effective ways to lower your taxable income is by maximizing your retirement contributions.

Contributions to retirement accounts, such as 401(k)s, traditional IRAs, and other tax-deferred retirement savings plans, reduce your taxable income because the money you contribute is deducted from your taxable income.

For example, in the U.S., for 2023, individuals under 50 can contribute up to $22,500 to a 401(k), and those over 50 can contribute an additional $7,500 as a catch-up contribution.

2. Take Advantage of Tax Credits

Tax credits are even more valuable than deductions because they directly reduce your tax bill, not just your taxable income.

There are several types of tax credits available, and taking advantage of them can significantly lower the amount of tax you owe. Some of the most common tax credits include:

Earned Income Tax Credit (EITC): Designed for low-to-moderate-income individuals and families, the EITC can reduce your tax bill or increase your refund.
Child Tax Credit: Parents can claim a credit for each dependent child under 17. For 2023, the Child Tax Credit is $2,000 per qualifying child.
Education Credits: The American Opportunity Tax Credit (AOTC) and Lifetime Learning Credit (LLC) help reduce the cost of post-secondary education by offering credits on tuition and related expenses.

Additionally, there are energy-efficiency credits for making eco-friendly home improvements, such as installing solar panels or energy-efficient windows.

Each of these credits directly lowers the taxes you owe, so it’s important to determine which ones apply to your situation.

→ SEE ALSO: Understanding Retirement Savings Plans

3. Leverage Health Savings Accounts (HSAs)

Health Savings Accounts (HSAs) offer a triple tax benefit that makes them an excellent vehicle for saving on taxes.

Contributions to an HSA are tax-deductible, the money in the account grows tax-free, and withdrawals for qualified medical expenses are also tax-free.

In 2023, individuals with a high-deductible health plan (HDHP) can contribute up to $3,850 to an HSA, while families can contribute up to $7,750.

Those 55 and older can make an additional $1,000 catch-up contribution.

Even if you don’t use the money for medical expenses right away, your contributions can continue to grow and accumulate interest.

HSAs act like a retirement account for healthcare expenses, and if you don’t use the funds, they carry over to the next year without penalty.

Understanding the Benefits of Health Savings Accounts (HSAs) for Long-Term Financial Wellness - Wedbush Securities

4. Invest in Tax-Loss Harvesting

Tax-loss harvesting is a strategy used to offset capital gains by selling investments at a loss. When you sell an investment at a loss, that loss can be used to reduce your taxable income.

This is particularly useful for investors with taxable brokerage accounts who experience both gains and losses throughout the year.

You can offset an unlimited amount of capital gains with capital losses, and if your losses exceed your gains, you can use up to $3,000 of the loss to offset ordinary income each year (or $1,500 if married filing separately).

If your losses exceed that limit, the excess can be carried forward to future tax years.

For example, if you had $10,000 in capital gains and sold an investment for a $5,000 loss, you could use that loss to reduce your taxable capital gains to $5,000.

Not only does this reduce your tax burden for the year, but it also provides an opportunity to reinvest the proceeds from the sale into more promising investments.

→ SEE ALSO: Creating an Effective Personal Budget

5. Utilize Charitable Donations

Charitable donations are another excellent way to reduce your taxable income. When you donate to a qualified charitable organization, you can deduct the value of your donation from your taxable income.

This includes cash donations as well as non-cash items like clothing, furniture, or even a vehicle.

To claim these deductions, it’s important to keep receipts and documentation of your contributions.

For cash donations, you’ll need a receipt or a bank record, and for non-cash donations valued at over $500, you may need to file Form 8283 with the IRS.

Additionally, for those who are 70 ½ years old or older and have a traditional IRA, you can donate up to $100,000 directly from your IRA to a charity, which counts toward your required minimum distribution (RMD) but does not increase your taxable income.

Conclusion

Reducing your taxable income involves taking advantage of a combination of retirement contributions, tax credits, health savings accounts, investment strategies like tax-loss harvesting, and charitable donations.

Each of these strategies allows you to legally lower your taxable income, ultimately keeping more money in your pocket.

While it’s essential to be proactive and strategic about tax planning, consulting with a tax professional or financial advisor can help you navigate the complexities of the tax code and maximize your savings.

By staying informed and taking advantage of available tax breaks, you can ensure that you are keeping as much of your income as possible while staying within the boundaries of the law.