The employer deducts taxes for every dollar one earns based on the total income earned annually. However, there are many ways to pay lesser tax by lowering the net taxable income without reducing their net take-home paycheck.
Here are five ways how to lower taxable income for the current year.
5 ways for lowering taxable income
-
How to pay less taxes – opt for Employee Stock Purchase Plan (ESPP)
As an employee of a publicly listed company, one is eligible for ESPP. Employees can buy stocks from their net paycheck. Usually, they get at a discount of around 15% available for employees. One can contribute up to 10% in ESPP, and in 2022, the maximum contribution is limited to $25000 a year.
The shares can be held for more than a year where one pays lower capital gains tax than ordinary higher income. This helps reduce taxable income and tax burden. One must not blindly participate in a stock plan. If this type of investment does not fit into the financial plan, it can be avoided.
-
Contribute to IRA or a 401(k)
Contributing pre-tax income into a traditional IRA or the 401(k) -employer-sponsored tax investment account. By investing and paying pre-tax in 401 (k), the net taxable income becomes lower and less tax is deducted. On the other hand, the deposited amount grows tax-free and becomes taxable only when withdrawn.
The contribution limit is $20,500 and an additional $6,500 for employees older than 50 to 401(k) account. For IRA, the annual contribution limit is $6000 and an extra $1000 for 50 years and above. The IRA is also tax-deductible when one files the tax and other factors like income level.
-
Contribution to health savings account
Another easy way how to lower taxable income is to contribute to a health savings account or HAS that takes care of emergency health expenses. The triple advantage of tax savings is that the funds go to a tax-free account and accumulate till it is withdrawn for medical expenses for co-pays, deductibles, and coinsurance. This contribution is deducted from the total income, reducing the tax burden.
The pre-tax contribution limit is $3,650 for an individual and $7,300 for a family, plus $1000 extra for ages above 55.
-
Student loan interest payment deduction
Student loan repayment from monthly installments consists of an interest component. The total interest paid annually can be deducted from the taxable income. The cut-off for claiming the deduction is $85,000 for an individual and $1,75,000 for a joint account.
-
Selling stocks in loss
It is normal to sell stocks in one’s portfolio at a loss. A tax-loss harvesting investment strategy can be used to one’s advantage. This means one can set off investment losses against their income. In a typical scenario, an investment gain would be taxable.
If one’s stock is not doing well, it is better to sell them at a loss and set it off from income up to $3000. Any excess losses can be set off in future years to lower the taxes.
Conclusion
The above five ways to reduce taxable income are popular. The common underlying message on lowering taxable income is to invest money from one’s paycheck and investing reduces or defers tax liability and makes money grow and compound over time.
