6 Strategies to Protect Income From Taxes

Income is taxed at federal, state, and local levels, and earned income is subject to additional levies for Social Security and Medicare. While avoiding taxes entirely is challenging, several strategies can help mitigate their impact. Here are some approaches to consider:

KEY TAKEAWAYS

  • Contributing to qualified retirement and employee benefit accounts with pretax dollars can exempt some income from taxation and defer taxes on other earnings.
  • Long-term capital gains are taxed at lower rates.
  • Capital loss deductions can further reduce your tax burden.
  • Interest income from municipal bonds is generally not subject to federal tax.

1. Invest in Municipal Bonds

Governments fund their obligations, such as maintaining infrastructure and public services, by selling municipal bonds, or “munis.” The key advantage of holding municipal bonds until maturity is that the interest earned is generally exempt from federal, and possibly state and local, taxes if you reside where the bond was issued. This tax-free interest makes munis appealing to many investors.

However, not all municipal bonds are tax-exempt. If purchased at a significant discount, a “de minimis” tax may apply, and the interest and gains from this discount are taxed as regular income. Despite typically offering lower interest rates, municipal bonds have a lower historical default rate compared to corporate bonds, making them a safer investment option.

2. Aim for Long-Term Capital Gains

Investing in stocks, mutual funds, bonds, and real estate can be a significant tool for wealth growth, partly due to favorable tax treatment on long-term capital gains. Assets held for more than a year are taxed at preferential rates of 0%, 15%, or 20%, depending on your income level. In contrast, short-term gains are taxed at regular income tax rates.

For 2024, the zero rate bracket for long-term capital gains applies to taxable income up to $94,050 for married couples filing jointly and $47,025 for single individuals. Utilizing strategies like tax-loss harvesting can offset capital gains taxes by allowing deductions for losses, with excess losses over $3,000 carried forward to future tax years.

3. Start a Business

Running a side business can offer numerous tax advantages alongside additional income. Many business-related expenses, including health insurance premiums for self-employed individuals, can be deducted from income. Home office deductions, when properly claimed, can reduce taxable income by deducting a portion of utilities and Internet expenses.

To claim these deductions, the IRS requires proof of a profit motive, typically demonstrated by showing a profit in three out of five years. Additionally, the SECURE Act of 2019 offers tax incentives to employers who join multiple-employer plans and provide retirement options for their employees.

4. Maximize Retirement Accounts and Employee Benefits

Contributions to retirement accounts like 401(k) or 403(b) plans can significantly reduce taxable income. In 2023, contributions up to $22,500 (rising to $23,000 in 2024) are allowed, with an additional $7,500 catch-up contribution for those aged 50 or older. This means an employee earning $100,000 who contributes the maximum amount can reduce their taxable income substantially.

For those without employer-sponsored retirement plans, contributing up to $7,000 ($8,000 for those 50 and older) to a traditional IRA in 2024 can offer tax benefits. The IRS provides specific guidelines on how much of these contributions can be deducted based on adjusted gross income and participation in other retirement plans.

How Can I Reduce My Taxable Income?

Experts recommend several strategies to reduce your taxable income. These include contributing to employee benefit plans like a 401(k), health savings accounts (HSA), flexible spending accounts (FSA), and traditional individual retirement accounts (IRA).

How Much Should I Contribute to My 401(k) to Reduce My Taxes?

401(k) accounts allow pre-tax contributions, meaning the money you contribute is not taxed at the time of contribution. This lowers your taxable income, resulting in a smaller tax bill. The more you contribute to your 401(k), the more you reduce your taxable income and tax liability.

What Deductions Does the IRS Allow for the Self-Employed?

The IRS permits self-employed individuals to deduct several expenses. These include costs associated with home offices, vehicles, cell phones, contributions to self-employed retirement plans, and self-employed health insurance premiums.

The Bottom Line

While it is crucial to pay the taxes legally required, there is no need to pay more than necessary. Spending some time researching on the IRS website (IRS.gov) and reputable financial information sites can potentially save you significant amounts in taxes.

Consulting with a tax professional is also advisable before claiming deductions on your tax return. This ensures you meet all qualifying rules and can confidently enjoy the savings from your diligent tax planning.

2024 Federal Income Tax Brackets, Standard Deductions, and Tax Rates

Every year, the Internal Revenue Service (IRS) updates federal income tax rates, allowances, and thresholds to reflect inflation adjustments. For individual taxpayers filing for the 2024 tax year in 2025, the highest tax rate is set at 37%. Standard deductions, tax bracket ranges, other deductions, and phaseouts also undergo annual inflation adjustments.

Key Takeaways:

  • The IRS annually revises federal tax rates, allowances, and thresholds for inflation.
  • Taxpayers can claim a standard deduction to lower taxable income and an additional deduction if they are 65 or older and/or blind.
  • Federal tax brackets for 2024 range from 10% to 37%.
  • Various individual tax credits are available, including the earned income credit and the qualified adoption expenses credit.
  • Contribution limits to tax-advantaged retirement accounts typically change each year.

Federal Tax Rates and Brackets

For the 2024 tax year, there are seven federal tax brackets: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. The highest income earners fall into the 37% bracket, while those with the lowest incomes are taxed at 10%. The tax rates and brackets for 2024 are detailed in the following chart.

Standard Deduction

The standard deduction is a specific amount that taxpayers can use to reduce their taxable income when filing their annual tax returns. Taxable income is calculated as your adjusted gross income (AGI) minus any itemized deductions or the standard deduction.

2024 Standard Deductions

For the 2024 tax year, the IRS has set the standard deduction amounts as follows:

  • $14,600 for single filers
  • $14,600 for married couples filing separately
  • $21,900 for heads of households
  • $29,200 for married couples filing jointly
  • $29,200 for surviving spouses

Additionally, individuals who are aged 65 or older or are blind can claim an extra standard deduction of $1,550. This amount increases to $1,950 for unmarried individuals who are not surviving spouses. Dependents can claim a standard deduction of $1,300 or $450 plus their earned income, whichever is higher.

Capital Gains

Capital gains tax rates are generally lower than ordinary income tax rates, but they vary based on the taxpayer’s taxable income and filing status. The maximum adjusted capital gains rates apply to both regular income tax and the alternative minimum tax.

For the 2024 tax year, you will need to pay capital gains tax if your income exceeds

  • $94,050 for married couples filing jointly
  • $47,025 for married couples filing separately
  • $63,000 for heads of households
  • $47,025 for single filers

The 15% capital gains rate applies to adjusted net capital gains for:

  • Joint returns up to $583,750
  • Married individuals filing separately up to $291,850
  • Heads of households up to $551,350
  • Single filers up to $518,900
  • For any income above these thresholds, the applicable capital gains rate is 20%.

Individual Tax Credits

Earned Income Tax Credit (EITC)

The Earned Income Tax Credit (EITC) is adjusted annually for inflation. For the 2024 tax year, the maximum EITC for taxpayers with three or more children is $7,830. For married couples filing jointly, the credit begins to phase out at an adjusted gross income (or earned income, if higher) of $29,640 and phases out completely at $66,819.

Qualified Adoption Expenses

For 2024, the credit for qualified adoption expenses, including the special credit for adopting a child with special needs, is set at $16,810. Additionally, the exclusion from an employee’s income for qualified adoption expenses paid or reimbursed under an employer plan is also increased to $16,810.

Lifetime Learning Credit

The Lifetime Learning Credit (LLC) provides a maximum of $2,000 per return for qualified educational expenses for a taxpayer, spouse, or dependent. This credit phases out for taxpayers with a modified adjusted gross income (MAGI) exceeding $80,000 ($160,000 for joint returns). Unlike other credits, the LLC has not been adjusted for inflation in recent years.

Foreign Earned Income Exclusion

The foreign earned income exclusion amount for the 2024 tax year is set at $126,500 by the IRS.

Alternative Minimum Tax

The Alternative Minimum Tax (AMT) applies to income above certain exemption levels, calculated by adding back specific tax benefits to regular taxable income. For the 2024 tax year, the AMT exemption levels are:

  • $133,300 for joint returns
  • $85,700 for unmarried individuals
  • $66,650 for married individuals filing separately

These exemption levels phase out at:

  • $1,218,700 to $1,751,900 for joint returns
  • $609,350 to $952,150 for unmarried individuals
  • $609,350 to $875,950 for married individuals filing separately

The AMT rate is 28% for alternative minimum taxable income up to $232,600 for joint and single filers ($116,300 for married individuals filing separately) for the 2024 tax year.

What Are the 2024 Tax Brackets?

The IRS has maintained the same seven federal tax brackets for 2024: 10%, 12%, 22%, 24%, 32%, 35%, and the top bracket at 37%. However, the income thresholds for these brackets have been adjusted upward to account for inflation. The amount of tax you owe will depend on your income and your filing status, such as single filer or married filing jointly.

How Did Standard Deductions Change for the 2024 Tax Year?

The standard deduction amounts have increased for 2024. The IRS has set the standard deductions as follows:

  • $14,600 for single filers
  • $14,600 for married couples filing separately
  • $21,900 for heads of households
  • $29,200 for married couples filing jointly
  • $29,200 for surviving spouses

Did the Child Tax Credit Change?

The child tax credit reverted to pre-2021 levels in 2022. For the 2024 tax year, the refundable portion of the $2,000 child tax credit for each child under 17 has been adjusted for inflation and is now $1,700.

The Bottom Line

Each year, typically in November, the IRS announces adjustments for federal taxes for the upcoming tax year. These adjustments include changes to tax brackets, standard deductions, tax credits, and more. Staying informed about these updates is crucial to ensure accurate tax filing and to avoid overpayment or underpayment.