3 Tax Planning Tips to Help Reduce Your Taxable Income

By Eric Rosenberg

PUBLISHED February 20
|
8 MINUTE READ

An unanticipated tax bill can be more than a disappointment—it might even derail your financial plans and delay your goals. While you can't go back in time and change your income and withholdings for last year (outside of some late retirement plan contributions), you can plan ahead to avoid owing next year.

You likely already know the basics—your tax rate is a percentage of your income. So, if you expect to have a similar income and expenses as last year, how can you emerge with a different tax bill? Here's a closer look at how your taxes work and what you can do to ensure you get a refund rather than owing next year.

1. Contribute to Pre-tax Retirement Plans

One way to shrink your taxable income and help your future self is to contribute to a tax-advantaged retirement plan, either through a workplace plan or a traditional IRA. These plans are tax-advantaged, which can lead to major long-term savings.

A tax-advantaged retirement account is a special savings account that helps you save for retirement with extra perks like tax breaks, either on the money you put in (tax deduction) or the earnings you make (tax-free growth or withdrawals).

There are different types of accounts, such as 401(k)s or IRAs, each with its own rules. When you contribute money to these accounts, you may get a tax break either when you put the money in (tax deduction) or when you take it out in retirement (tax-free withdrawals). The account then allows your savings to grow over time, often with investments, without incurring immediate taxes on the gains. This tax advantage is intended to promote long-term savings and financial security during retirement.

For instance, if you have a yearly income of $60,000, your income tax is calculated based on that amount. But if you add $5,000 to a 401(k) or traditional IRA, you can reduce your taxable income to $55,000, meaning you would pay less in taxes for this year. The $5,000 contribution can grow in your IRA until you withdraw in retirement. Contributing to your IRA every year helps build your retirement nest egg while also saving on taxes.

For the 2023 tax year, the annual limit on IRA contributions is $6,500, or $7,500 if you're age 50 or older.¹ You will owe taxes on traditional IRA withdrawals in retirement, but likely at a lower tax rate than during your prime working years.

With a Roth IRA, on the other hand, you pay taxes on contributions, but qualified withdrawals in retirement are tax-free. If you withdraw from either account before the government-allowed age, you'll owe taxes and additional penalties.

Tax benefits of IRAs

Saving for retirement can make a difference on your taxes. Here's a snapshot of a simple example of what a single tax filer can save by making the maximum pre-tax IRA contribution last year (2023).

	No IRA contribution	With IRA contribution
Income	$60,000	$60,000
Traditional IRA contribution	$0	$6,500
Taxable income	$60,000	$53,500
Federal tax due	$10,051	$9,128

That's a savings of more than $900 in taxes for the year of your contribution, and you get to keep the money for retirement. If you can afford to contribute the maximum and save nearly $1,000 per year on your taxes while also saving and investing for retirement, that's a win-win for your finances.

Learn more about saving with an IRA.

2. Maximize Tax Deductions

The major tax law passed in 2017 increased the standard deduction, which is how much you can lower your taxable income by default.² You can still itemize deductions if they add up to more than the standard deduction, but you can't both claim the standardized deduction and itemized deductions—it must be one or the other.

Tax deductions lower your taxable income. So a $1,000 deduction doesn't translate to $1,000 off your tax bill. It means your taxes will be calculated on a smaller income, in this example by $1,000.

For the 2023 tax year, the standard deduction is $13,850 for single filers and those married filing separately, $27,700 for married filing jointly, and $20,800 for heads of household.³ Common deductions to review when doing your taxes include the following:

• Charitable donations: You can deduct contributions to a qualified charity, including the value of items you donate. Limits apply, but donating to nonprofits can feel great while also lowering your tax bill.
• Health savings accounts (HSAs) and eligible medical expenses: If you have a tough medical or dental year, you can deduct eligible expenses if they exceed 7.5% of your adjusted gross income.⁴ This includes direct medical costs and travel to medical appointments. Either way, if you're eligible to contribute to an HSA, you'll qualify for a deduction.
• State and local taxes: State and local taxes, sometimes referred to as SALT, are deductible expenses. If you live in an area with high property taxes, your SALT deduction can add up to significant tax savings quickly.
• Mortgage interest: If you have a mortgage loan attached to your home, you can generally deduct mortgage interest expenses, including points if you have a new or refinanced mortgage. You may be able to deduct interest from a second mortgage as well. Limits and restrictions apply.
• Student loan interest: If you made student loan payments, your student loan interest costs are deductible. As with most deductions, limits apply. You can deduct up to $2,500 in student loan interest for 2023 income taxes filed in 2024.⁵

3. Use Tax Credits

Tax credits directly reduce the amount of tax you have to pay. Some credits are refundable, meaning that if you owe no tax, you can be paid the amount of the credit as a refund. Here are a few areas where credits might affect next year's tax bill:

• Saving money: If you saved money in a retirement account, you may be eligible for the Saver's Credit. Income limits apply.
• Child tax credit: Most families can take $2,000 off their taxes for every dependent child up to age 17.⁶ Income limits apply. If you're considered a middle- to low-income household, you may also qualify for the Earned Income Tax Credit, a refundable tax credit that increases depending on how many kids you have. You can get the credit if you don't have kids, it's just significantly less.
• Education costs: Interested in furthering your education or career training? It can help next year's tax bill. Qualified education expenses may qualify you for the lifetime learning credit or the American opportunity tax credit.

Learn more about deductions vs. credits.

Plan Ahead for Next Year's Taxes

While you can't predict the future with certainty, you can estimate your income, deductions and credits for next year to plan ahead for tax filing. If you're in doubt and want to avoid paying when filing your tax return, consider increasing your withholdings. To do so, contact your employer and file an updated W-4 form. Also, boosting your contributions to a tax-advantaged retirement account can make a huge difference. If you estimate well, you can turn that tax expense into a refund.

Eric Rosenberg is a financial writer, speaker and consultant based in Ventura, California. He is an expert in banking, credit cards, investing, cryptocurrency, insurance, real estate, business finance and financial fraud and security. His work has appeared in many online publications, including Time, USA Today, Forbes, Business Insider, NerdWallet, Investopedia and U.S. News & World Report. Connect with him and learn more at EricRosenberg.com.

TAXES