There are many legitimate ways a taxpayer can reduce their tax liability. Consider the options below to help reduce yours…
1.Contribute to a Retirement Account
Max contribution: $20,500
Contributing to retirement plans is one of the easier ways to reduce your taxable income. 401(k)s and 403(b)s are some of the most common retirement accounts that you can make tax deductible contributions to. Some employers will match your contributions, which means you’ll get free money.
The max contribution is $20,500 for 2022, and additional $6,000 if you are 50 years or older. The contribution benefits adjust for inflation each year so expect it to go up next year.
2. Health Savings Account (HSA)
Maximum contribution: Individuals $3,650 or family $7,300
If you have an eligible high deductible medical plan, contributing to a health savings account can lower your taxable income. HSAs have the potential to be triple tax advantaged. Contributions to these accounts offer a tax deduction, grow-tax deferred and can be withdrawn tax-free for qualified medical expenses.
If you do not have a high deductible health plan, you can opt for the FSA for medical expenses. The drawback of this account is the lower contribution amount ($2,850) and there is a use or lose it rule. If you don’t use the money by the end of the year, the max you can rollover is $570 if your employer allows carryovers.
3. Tax Loss Harvesting
Max deduction: $3,000/year
Tax loss harvesting is when you sell an investment(s) at a loss to offset gains you’ve realized by selling other stocks at a profit. The result is you only pay taxes on your net gains. If your losses are larger than your gains, you can use the capital loss to offset ordinary income. This can be up to $3,000 per year. Loses more than $3,000 can be carried forward indefinitely until the amount is exhausted.
For more information on tax loss harvesting, check out my previous post “Benefits of Tax Loss Harvesting”.
4. Long Term Capital Gains
0%, 15%, or 20% tax rate
If you hold a position for more than a year and sell it for a gain, you will be able to utilize the long-term capital gains tax rate. On investments held less than one year, you will pay ordinary income tax.
There’s a 0%, 15%, and 20% long term capital gains rate based on your income (see below). These tax rates are generally much lower than the ordinary income taxes. Click here to calculate your capital gains tax.
5. 529 Plan
State tax deduction: $10,000 single or $20,000 married
Saving for education expenses can help shave a few bucks off your tax bill. A popular option is to make contributions to a state sponsored 529 Plan.
For Illinois, contributions to a 529 plan are tax deductible. You’ll enjoy a deduction of up to $10,000 per year ($20,000 if married and filing jointly) and you pay no state income tax on earnings and withdrawals that are used for qualified education expenses (Source: Bright Directions).
6. Traditional IRA
Max contribution: $6,000 / or $7,000 for 50 or older
There are two major types of individual retirement accounts: Roth IRAs and traditional IRAs. Depending on your income you may be eligible for more tax deductions by putting money into your traditional IRA. To view the traditional IRA deduction limits, click here.
7. Miscellaneous Tax Deductions
These are smaller and less common above-the-line deductions taxpayers can use:
- Up to $250 of unreimbursed expenses for educators who work in schools
- Up to $2,500 of student loan interest
- Up to $300 deduction for charitable donations ($600 married couples)
- Business expenses of reservists, performing artists, and fee-based government officials
- Moving expenses for members of the Armed Forces.
- The deductible part of self-employment tax.
- Health insurance premiums for self-employed people
- Penalties on early withdrawal of savings
- Alimony payments (for divorce agreements dated before Dec. 31, 2018)
- Contributions to an Archer MSA
8. States with no income tax
With remote work becoming more common, many people have moved to states with no income tax. These states include Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming. Illinois has a flat income tax of 4.95%.
Bottom Line
If you opt for the standard deduction (Estimated 90% of taxpayers) there are still ways to save for the future and trim your current tax bill. I’ve personally used 7/8 of these strategies to reduce my own tax liability and recommend you take advantage of them as well. If you have any questions, please do not hesitate to reach out.
George Maroudas
847-550-6100
george@pmgwealth.com
Twitter @ChicagoAdvisor
Disclaimers and Sources:
Smart Asset: Capital Gains Tax Calculator
Forbes: Tax Loss Harvesting
Bank Rate: Standard vs Itemized Deduction.
Bright Directions: 529 Plan Tax Information
Forbes: Charitable Deduction
Investopedia: Student Loan Interest Deduction
Forbes: Above-the-line Deductions
Investopedia: 2021 & 2022 Deduction Limits
Stock investing includes risks, including fluctuating prices and loss or principal. This information is not intended to provide specific advice or recommendations about any stock nor is it intended to be a recommendation to buy, sell or hold any stock investment. We suggest speaking with your financial professional about your situation prior to investing.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions apply.
Please consult your financial advisor regarding your specific situation. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. All investing involves risk including loss of principal. No strategy ensures success or protects against loss. This information is not intended to be a substitute for specific individualized tax advice. The Standard & Poor’s Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
Prior to investing in 529 Plan investors should consider whether the investor’s or designated beneficiary’s home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state’s qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
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