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Here are 5 ways to reduce your taxable income
1. Enroll in an Employee Stock Purchase Program
If you work for a publicly traded company, you may be eligible to enroll in a Employee share ownership plan (ESPP). By enrolling in your ESPP, you’ll divert after-tax dollars from your paycheck to buy stock in your company, and in many cases you’ll get a discount (usually around 15%) on the share price which is only available to employees.
You can choose the after-tax amount you want to contribute to your ESPP, which typically ranges between 1% and 10%. Keep in mind, however, that the maximum contribution limit for 2022 is $25,000 total per year.
The tax benefit of joining an ESPP comes into play when you decide to sell your shares. While employees can choose to sell their shares immediately after purchase or at a later date, they are rewarded if they hold onto their shares for at least one year from the date of purchase. Selling now means you pay ordinary income tax, while selling later means you pay less long-term capital gains tax, reducing your tax liability.
While it might be a good idea to take advantage of buying your employer’s stock at a discount, while still benefiting from holding your stock for the long term, make sure you 1) have enough money to contribute and 2) that the investment fits into your overall budget. financial plan. Certain financial goals, such as paying off high-interest debt, building an emergency fund, and contributing to an IRA or 401(k) — and meeting any consideration from the employer – must first be achieved before participating in a shareholding plan.
2. Contribute to a 401(k) or Traditional IRA
One of the easiest and potentially most beneficial ways to reduce your taxable income is to contribute to a pre-tax retirement account, such as an employer-sponsored 401(k) or a traditional IRA. With either of these tax-advantaged investment accounts, money from your paycheck (in the case of a 401(k)) or bank account (in the case of a traditional IRA ) enters before being taxed.
With pre-tax contributions, you also take less of your disposable income now, which is better for your immediate cash flow. However, your money grows tax-free and, later in retirement, you will have to pay tax on the funds you withdraw.
In 2022, the contribution limit for a 401(k) is $20,500, with an additional $6,500 available for those age 50 and older. The annual contribution limit for IRAs is $6,000 (between traditional and Roth IRA accounts), with an additional $1,000 available for those age 50 and older.
With a traditional IRA, your contributions can also be tax deductibledepending on your income, your tax situation and whether or not you have a pension plan through your employer.
“Many people are eligible to deduct their traditional IRA contributions, which can help reduce their tax liability,” says Corbin Blackwella VTC at Improvement, a robo-advisor offering traditional, Roth, and SEP IRAs. “However, not all IRA contributions are tax deductible, so be sure to work with your tax preparer to understand your situation.”
Basically, you cannot make a deduction if you (or your spouse, if married) have a workplace pension plan and your income is $78,000 or more as a sole filer/head of household, 129 $000 or more as a jointly filing spouse/eligible widow(er) or $10,000 or more as a married filing separately. If you (and your spouse, if married) do not have a retirement plan at work, you can make a full deduction up to the amount of your contribution limit.
3. Contribute to a health savings account
A Health Savings Account (HSA) is a medical savings account designed for taxpayers with a High Deductible Health Plan (HDHP) to save for future health care expenses.
This account is known by some as “Triple Tax Advantage” because the funds are tax-exempt (or tax-deductible if you opened your own account), can grow tax-free in investing the balance and being withdrawn tax-free at any time. time if used for eligible medical expenses – things like deductibles, copayments, and coinsurance. These three tax advantages each contribute to reducing your tax burden. Additionally, your HSA balance, if not fully utilized, will carry over from year to year.
Some employers offer an HSA benefit to their employees, while others may need to open their own HSA away from their workplace. If your employer sponsors an HSA plan, see if they contribute a flat amount or match employee contributions. Keep in mind, however, that all employer contributions count toward the IRS maximum annual limits.
The limits on pre-tax funds paid to an HSA for 2022 are $3,650 for a single person and $7,300 for a family, plus an additional $1,000 if you’re 55 or older.
4. Deduct the student loan interest you paid
While student loans can be a burden, the interest you’ve paid can be a simple deduction from your taxable income. For 2022, if your modified adjusted gross income (MAGI) is less than $70,000, or $145,000 in joint filing, you can deduct up to $2,500. If you earn above certain thresholds, you can deduct a prorated amount. The thresholds for claiming a deduction are over $85,000 for single taxpayers and over $175,000 for joint filers.
If you have federal student loans, payments have been frozen and all interest has stopped accumulating for about two years. However, federal student loan repayments are expected to resume on May 1. So if you’re paying interest on student loans this year and you meet the income and tax return requirements, you will be able to deduct them from your taxable income in 2023.
5. Sell your losing stocks
It’s normal to have stocks in your portfolio that aren’t performing well. The good news is that a popular investment strategy called tax-loss harvesting can help you take advantage of a market downturn.
Reaping tax losses essentially means using your investment losses to offset the taxes you would pay on other investment gains, which would otherwise reduce your taxable income.
Amanda Gutierrez, CFP and Financial Planning Consultant at e-money advisor, suggests investors look into tax loss reaping: “Investors can sell losing stocks and realize capital losses, which can be used to offset capital gains,” she told Select. “For those without capital gains, these losses can offset up to $3,000 of ordinary income. Any excess loss can be carried forward to future years and used to reduce taxes.”
While you can certainly implement tax loss collection yourself, it’s easy to do so through robo-advisor services like Improvement, wealth front Where Charles Schwabwhich each automatically seek out opportunities to regularly reap losses, thereby reducing investors’ tax exposure throughout the year.
Robo-advisors offer a simple way to start investing, but we suggest talking to your financial advisor about what they recommend as the best tax harvesting strategy for you.
And, at tax time when you have reaped investment losses, use tax software like TurboTax Where H&R block to make it easier to properly capture and claim these losses on your taxes, which will hopefully reduce your overall tax bill.
Editorial note: Any opinions, analyses, criticisms or recommendations expressed in this article are those of Select’s editorial staff only and have not been reviewed, endorsed or otherwise endorsed by any third party.