9 Strategies to Reduce Your Taxable Income

Taxes are never good news, but with a couple of smart financial moves, it is possible to reduce the tax bill and save money for more pleasant purchases. In this article, we will review several proven ways to reduce taxable income and improve your financial situation with tax-efficient instruments. Here, you’ll find professional insights into how business ownership can grant you tax benefits, how to maximize your retirement contributions, and a few other strategies for you to consider.

Invest in Tax-Efficient Financial Instruments

Let’s start with two basic financial instruments that offer tax advantages and ease the pressure of paying bills: municipal bonds and long-term capital gains.

Municipal bonds

Buying a municipal bond is your ticket to maximizing efficient tax savings. How? The process is relatively straightforward: you lend money to the issuer and receive a return with interest in exchange. Localities and states can issue bonds to support road reconstruction and school improvement projects, for example. Sure, the interest rate is lower than that of the corporate option, but if you keep the bond until it matures, you will not have to pay federal income tax on the interest you get from the deal. As a pleasant bonus, if you live in a location where the bond takes place, you usually won’t have to cover state and local taxes.

Long-term capital gains

Long-term gains are one of the best ways to reduce the tax bill, as they typically have lower tax rates than ordinary job or wage earnings. For example, ordinary income tax reached 37% in 2024, while long-term investments are taxed at reduced rates that depend on current tax laws and your income bracket. Note that you can consider a long-term capital gain only on the assets you hold for over a year or more.

Additionally, you can utilize a tax-loss harvesting strategy. In simple terms, it allows you to deduct your losses from gains to lower your taxable income.

Use Business Ownership for Tax Benefits

The IRS (Internal Revenue Service) supports businesses by allowing business owners to deduct a significant portion of their essential operational expenses. This makes starting a business one of the ways to lower a tax bill. Expense cuts are applied to:

• Home offices.
• Internet and utilities.
• Vehicles used in business operations.
• Phone bills related to business calls.
• Business trips.
• Retirement plan contributions.
• Insurance premiums for self-employed individuals.

These options are appealing, but keep in mind that you can deduct this tax only if you operate a business for profit rather than as a hobby.

Max out Retirement Contributions

If you are asking yourself, "What can I do to lower my tax bill?", the simplest answer is likely to contribute to retirement accounts and ensure tax savings for the future.

Some employers offer retirement accounts, such as 401(k) and 403(b) plans. This way, all required contributions will be deducted from paychecks before tax and, as a result, will reduce your taxable income. Employed individuals can contribute up to 25% of their salary (not more than $30,000 per year) to their 401(k) plan. Once they reach 59 and a half years of age, they can withdraw their savings without penalties.

If your employer doesn’t offer retirement contribution plans, no worries; you still have an opportunity to benefit from an IRA. You can also lower your tax bill via an individual retirement account by depositing your income before taxes into investments for further tax-deferred growth.

With SECURE 2.0, employers get the right to designate contributions as Roth ones instead of the pre-tax option if the plan permits it. So, instead of getting a deduction now, employees can contribute to after-tax accounts and withdraw their contribution and earnings on a tax-free basis. The limit to annual contributions is $7,000 USD, and according to SECURE 2.0, it includes a cost-of-living adjustment, which increases by $1,000 per year.

Need professional help? Rates.fm will gladly aid you in understanding tax reduction options.

Benefit from Health Savings Accounts (HSAs)

When thinking about how to reduce taxable income, a health savings account is probably not the first thing that comes to mind. Still, this practice is one of the most efficient and beneficial options you can go for, as it allows you to take care of both your financial and physical well-being. Similar to a 401(k) plan, an HSA is funded via your paychecks. When using an HSA, you can withdraw money to pay for medical expenses tax-free. An HSA doesn’t have an expiration date, and you can invest in it until your retirement.

Annual contribution to HSA has certain limits you’ll need to keep in mind:

• 4,300 USD for an individual high-deductible health plan.
• 8,559 USD for family coverage.

Employers can add to their employees’ healthcare savings by contributing to their HSAs. Such contributions can take the form of matching or seeding. Matching means that employers put in the same amount as the account owner. Flat contribution, also known as seeding, means that the same amount is contributed regardless of the account owner's contribution. Employer contributions are a great benefit to have, as they are tax-free when HSAs are concerned, providing another opportunity to reduce taxable income.

Claim Tax Credits to Maximize Savings

Wondering how to lower your tax bill by claiming credits? In simple terms, it is a dollar-for-dollar tax reduction. Let’s take a closer look at some of the common tax credits that can be useful for a taxpayer with low-to-average earnings.

Child tax credit

The child tax credit is ideal for families with children, stepchildren, siblings, or descendants under the age of 17. It works only if the children live with you for more than ½ of the tax year. Additionally, the full credit amount is available only if your annual income does not exceed $200,000 USD.

EITC

EITC stands for Earned Income Tax Credit, and it is one of the most effective ways to lower tax bill for low-income taxpayers. This credit is based on the taxpayer's current income, the number of children in their family, and their marital status.

The maximum credit amount is determined like this:

• For families without children — 632 USD.
• 1 child — 4,213 USD.
• 2 children — 6,960 USD.
• 3 or more — 7,830 USD.

AOTC

AOTC, or the American Opportunity Tax Credit, helps eligible students cover educational costs for their four years of higher education. The maximum credit a student can receive in a single year is $2,500.

LLC

If you’re still wondering how to reduce your tax bill, the lifetime learning credit offers another way to cover educational expenses.

LLC assists students with paying for:

• Undergraduate.
• Graduate.
• Professional degree course.
• Courses for job skills improvement.

Among the main requirements for the lifetime learning credit is to go to be enrolled in an eligible educational institution for at least 1 period that begins during the current tax year. This tax has no limitation on the number of years for claiming credit. With this option, you may receive up to 2,000 USD/tax in return. However, note that this sum can be reduced if your modified adjusted gross income (MAGI) falls between $80,000 and $90,000. You will not have an opportunity to apply for this credit if your MAGI exceeds $90,000.

Final thoughts

“How to reduce my tax bill?” is a common question for many taxpayers.  You can significantly cut tax expenses by applying various strategies, such as investing in financial instruments. Check the requirements and eligibility for tax credits to find the solution that best suits your current financial and life situation. The more you know about your options, the easier it is to lower the tax bill.