Take Action Now to Reduce Your 2023 Tax Liability
The end of the year is a popular time to read articles on how you can reduce your tax bill. Here are a few changes you can make now, at the beginning of the year, that can have a positive impact on reducing your tax burden for this year.
Income tax brackets for 2023
The tax rates themselves didn’t change from 2022 to 2023. There are still seven tax rates in effect for the 2023 tax year: 10%, 12%, 22%, 24%, 32%, 35% and 37%. However, as they are every year, the 2023 tax brackets were adjusted to account for inflation. That means you could wind up in a different tax bracket when you file your 2023 federal income tax return than the bracket you were in before – which means you could pay a different tax rate on some of your income.
How to get into a lower tax bracket and pay a lower rate
The key, of course, is reducing your taxable income. Fortunately, there are a number of easy (and smart!) things you can do yourself to knock down the taxable income on your next return. For example, putting money into a traditional IRA or 401(k) account will reduce your taxable income because contributions to these accounts are made on a “pre-tax” basis, which means what you put in doesn’t count as income (up to a certain limit). Plus, you receive the added benefit of building your nest egg for retirement.
And, don’t forget about tax credits. While they don’t reduce taxable income because they’re subtracted after your tax is calculated, these are actually more valuable than tax deductions, since they are subtracted on a dollar-for-dollar basis from your tax bill. For example, if you’re in the 22% tax bracket, a $1,000 tax deduction will save you $220 ($1,000 x .22 = $220). However, a $1,000 tax credit can actually be worth $1,000 (unless it’s a nonrefundable credit and your tax bill is less than $1,000). There’s a wide variety of tax credits available, such as for education expenses, saving for retirement, energy-efficient upgrades to your home, buying an electric vehicle or EV charging equipment, having a child, and child and dependent care expenses – just to name a few.
Max out your retirement contributions
As stated previously, less taxable income means less tax owed. Making contributions to a retirement account is a great way to reduce taxable income. There are several options to choose from:
- Company-sponsored 401(k) plans offer a significant benefit because employers often match contributions. Try increasing your 401(k) contribution so that you are investing the maximum amount of money allowed. The maximum contribution limit for 2023 is $22,500, plus an extra $7,500 if you are age 50 or over. If you can’t afford that much, try to contribute at least the amount that will be matched by your employer. Another suggestion would be to increase your annual contributions every time you receive a raise.
- If you don’t have access to a company 401(k), consider contributing to an IRA. For 2023, you can contribute a maximum of $6,500 to an IRA, plus an extra $1,000 if you are age 50 or older.
- If you’re self-employed, consider investing in a Simplified Employee Pension (SEP). You can contribute as much as 25% of your net earnings from self-employment, up to $66,000.
Contribute to a Health Savings Account (HSA)
If you have a high-deductible health care plan, you can reduce your taxable income by contributing to an HSA. A health savings account allows you to make tax-deductible contributions, earn tax-free interest, and withdraw tax-free funds for eligible medical expenses. The 2023 contribution limits are $3,850 for individual coverage and $7,750 for family coverage. Account owners age 55 or older can make an additional $1,000 contribution annually.
Consider a Qualified Charitable Distribution (QCD)
A QCD is a tax benefit that allows owners of individual retirement accounts to transfer funds from their pre-tax IRA directly to qualifying charities. The donated funds count toward satisfying the annual required minimum distribution but are excluded from income, thereby reducing adjusted gross income. The maximum annual amount that can qualify for a QCD is $100,000. Note: Beginning in 2024, the limit for qualified charitable distributions will be indexed to inflation.
There are countless tax-saving strategies you can implement at the beginning of the year that can save you from drowning with tax liabilities. Make sure you consult with your trusted advisors, e.g. accountant, financial advisor, attorney, etc., early and often to ensure you are achieving your financial goals while minimizing your tax burden.