1. Maximize Retirement Contributions
One of the most effective ways to lower your taxable income before the year ends is by maximizing your contributions to retirement accounts. Contributing the maximum allowed to 401(k) or IRA accounts not only helps you save for the future but also provides tax advantages today.
How Retirement Contributions Reduce Your Tax Bill
When you contribute to a traditional 401(k) or IRA, your taxable income is reduced by the amount you contribute, potentially lowering your overall tax liability. Additionally, these contributions grow tax-deferred until withdrawal during retirement.
Contribution Limits for 2024
| Retirement Account | Contribution Limit (Under 50) | Catch-Up Contribution (50+) |
|---|---|---|
| 401(k) | $23,000 | $7,500 |
| Traditional & Roth IRA | $7,000 | $1,000 |
(1) Take Advantage of Employer Matching
If your employer offers a 401(k) match, make sure youre contributing enough to receive the full match. Otherwise, youre leaving free money on the table.
(2) Consider a Roth Conversion
If you expect your tax rate to be higher in retirement, converting some of your traditional IRA funds to a Roth IRA might be beneficial. While youll pay taxes now, qualified withdrawals in retirement will be tax-free.
(3) Make Contributions Before December 31
For 401(k) plans, contributions must be made by December 31 to count for the current tax year. However, IRA contributions can be made until the tax filing deadline, typically in April of the following year.
2. Harvest Tax Losses
If you have investments that have declined in value, you can use a strategy called tax-loss harvesting to offset capital gains and potentially lower your taxable income. This involves selling underperforming assets to realize losses, which can then be used to offset capital gains or, in some cases, reduce ordinary income.
How Tax-Loss Harvesting Works
Tax-loss harvesting allows you to strategically sell losing investments and use those losses to your advantage. Here’s how it works:
- Offset Capital Gains: If you’ve sold profitable investments earlier in the year, you can use realized losses to offset those gains, reducing the amount of taxes owed.
- Reduce Ordinary Income: If your losses exceed your gains, you can deduct up to $3,000 ($1,500 if married filing separately) from your ordinary income per year.
- Carry Over Excess Losses: If your total losses exceed the $3,000 limit, you can carry them forward into future tax years to offset future gains or income.
Example of Tax-Loss Harvesting
| Investment | Gain/Loss | Tax Impact |
|---|---|---|
| Stock A (sold at a profit) | $5,000 gain | Taxable capital gain |
| Stock B (sold at a loss) | $4,000 loss | Offsets Stock A’s gain |
| Total Net Gain | $1,000 gain | Only $1,000 is taxable instead of $5,000 |
Avoid the Wash Sale Rule
The IRS has a rule called the wash sale rule, which prevents investors from claiming a loss if they repurchase the same or a substantially identical security within 30 days before or after selling it. To ensure your tax-loss harvesting is valid:
- Avoid buying back the same stock or asset within 30 days.
- If you want to stay invested in the market, consider buying a similar but not identical investment.
- Work with a financial advisor to ensure compliance with IRS regulations.
3. Make Charitable Contributions
Donating to qualified charities is a great way to support causes you care about while also reducing your taxable income. By making charitable contributions before December 31, you may be able to claim deductions on your tax return, lowering your overall tax bill.
How Charitable Contributions Reduce Your Taxes
When you donate to an IRS-qualified 501(c)(3) organization, you may be eligible to deduct the donation from your taxable income. This means you can lower the amount of income that is subject to taxation, potentially placing you in a lower tax bracket.
(1) Standard Deduction vs. Itemized Deduction
To benefit from charitable deductions, you must itemize your deductions instead of taking the standard deduction. Here’s a quick comparison:
| Deduction Type | Description | Best For |
|---|---|---|
| Standard Deduction | A fixed deduction amount set by the IRS | Taxpayers with fewer deductible expenses |
| Itemized Deduction | Allows taxpayers to deduct specific expenses, including charitable donations | Taxpayers with total deductions exceeding the standard deduction amount |
(2) Donating Appreciated Assets for Added Tax Benefits
Instead of donating cash, consider giving appreciated assets such as stocks or mutual funds. This strategy provides two key benefits:
- You avoid paying capital gains tax on the appreciation.
- You can deduct the full fair market value of the asset (if held for more than one year).
(1) Example of Donating Appreciated Assets vs. Cash
| Donation Type | Stock Donation ($10,000) | Cash Donation ($10,000) |
|---|---|---|
| Original Cost Basis | $5,000 | $10,000 |
| Capital Gains Tax Avoided (Assuming 15%) | $750 | N/A |
| Total Tax Deduction Value | $10,000 | $10,000 |
| Total Tax Savings (Assuming 24% Tax Bracket) | $2,400 + $750 = $3,150 | $2,400 |
Tips for Maximizing Charitable Deductions Before Year-End
(1) Keep Proper Documentation
The IRS requires proof of charitable contributions. Keep receipts, acknowledgment letters from charities, and bank records.
(2) Consider Donor-Advised Funds (DAFs)
If you’re unsure where to donate but want the tax deduction this year, contribute to a donor-advised fund and decide later which charities will receive grants.
(3) Bundle Donations for Greater Impact
If your total itemized deductions are close to the standard deduction threshold, consider “bunching” multiple years’ worth of donations into one year to maximize tax benefits.
Making charitable contributions before December 31 can be a win-win strategy—helping both those in need and your tax situation.
4. Defer Income and Accelerate Deductions
One effective way to lower your taxable income before the year ends is by deferring income to the next tax year while accelerating deductible expenses. This strategy can help reduce your tax liability, especially if you expect to be in a lower tax bracket next year.
How Deferring Income Works
If you are self-employed or have control over when you receive payments, consider delaying invoicing until late December so that payments are received in January. This pushes that income into the following tax year.
Ways to Accelerate Deductions
On the flip side, prepaying certain deductible expenses can help you maximize tax benefits this year. Here are some common deductions you may want to accelerate:
| Deductible Expense | How to Accelerate |
|---|---|
| Mortgage Interest | Make an extra mortgage payment before December 31. |
| Medical Expenses | Schedule and pay for medical procedures or treatments before year-end. |
| Charitable Contributions | Donate to qualified charities before the end of the year. |
| State and Local Taxes (SALT) | Prepay property taxes or estimated state taxes if not subject to SALT deduction limits. |
Who Benefits Most from This Strategy?
This approach is particularly useful for taxpayers who:
- Expect their income to decrease next year.
- Are close to a higher tax bracket and want to stay in a lower one.
- Itemize deductions instead of taking the standard deduction.
Key Considerations
(1) Alternative Minimum Tax (AMT)
If youre subject to AMT, some deductions like state and local taxes may not provide any benefit. Consult a tax professional before prepaying expenses.
(2) Future Tax Law Changes
If tax rates are expected to rise in the future, it might make sense to recognize more income now rather than deferring it.
(3) Cash Flow Impact
Ensure that deferring income or prepaying expenses aligns with your financial situation so you don’t create cash flow issues.
By strategically managing income and deductions, you can reduce your taxable income and potentially save on your tax bill this year.
5. Use Flexible Spending Accounts (FSAs) and Health Savings Accounts (HSAs)
Maximizing your contributions to FSAs and HSAs before the year ends can help you save on taxes while covering qualified medical expenses with pre-tax dollars. These accounts are designed to reduce your taxable income, making them a smart way to lower your tax bill.
(1) Understanding FSAs and HSAs
Both FSAs and HSAs allow you to set aside pre-tax money for medical expenses, but they have key differences:
| Feature | FSA | HSA |
|---|---|---|
| Eligibility | Available through employers | Must be enrolled in a high-deductible health plan (HDHP) |
| Contribution Limits (2024) | $3,200 per individual | $4,150 for individuals, $8,300 for families |
| Rollover | Limited rollover or use-it-or-lose-it | No expiration, funds roll over annually |
| Tax Benefits | Contributions are pre-tax | Contributions are tax-deductible, grow tax-free, and withdrawals for medical expenses are tax-free |
(2) Maximizing Your FSA Contributions
If you have an FSA, check your balance before the end of the year. Many FSAs have a “use-it-or-lose-it” policy, meaning unused funds may not carry over. Some employers allow a small rollover or grace period, so confirm your plan’s rules.
(1) Ways to Use Remaining FSA Funds
- Schedule doctor visits, dental checkups, or vision exams.
- Purchase eligible medical supplies like eyeglasses or contact lenses.
- Pay for prescriptions or over-the-counter medications with a doctors prescription.
- Consider physical therapy or chiropractic care if covered by your plan.
(3) Contributing to an HSA Before Year-End
If youre enrolled in an HDHP, contributing to an HSA before December 31 helps maximize your tax savings. Unlike FSAs, HSAs don’t have a spending deadline—your funds roll over indefinitely.
(1) Key HSA Tax Advantages
- Your contributions reduce taxable income.
- Earnings grow tax-free when invested.
- You can withdraw funds tax-free for qualified medical expenses at any time.
- If unused by retirement age (65), HSA funds can be withdrawn penalty-free for non-medical expenses (income tax still applies).
