One of the most popular financial planning issues among people and company owners is how to reduce taxes. The Tax Cuts and Jobs Act (TCJA) boosted basic deductions, which resulted in tax savings for many people (even though the TCJA did eliminate many other itemized deductions and the personal exemption).
A few intelligent methods may minimize taxable income even more.
- Contributing to a retirement account, whether via an employer-sponsored plan or an individual retirement account, is an efficient approach to minimize taxable income (IRA).
- Both health spending accounts and flexible spending accounts assist to minimize taxable income during the years in which they are funded.
- For full- or part-time self-employed individuals, a long number of deductions are available to reduce taxable income.
- You may reduce your taxable income by saving for retirement.
- Some workplaces have flexible spending plans, so inquire about them.
Save for Retirement
Maximizing retirement savings is one of the most easy methods to lower taxable income. Although there are many other kinds of retirement savings accounts to select from, the two most prevalent that may assist lower taxable income in the tax year in which a contribution is made are shown below.
Those whose workplace provides an employer-sponsored plan, such as a 401(k) or 403(b), may contribute up to $19,500 in 2021 and $20,500 in 2022. Those aged 50 and above may make further catch-up payments of $6,500 in 2021 and 2022.
Because contributions are paid pretax via payroll deferrals, money saved in an employer-sponsored retirement plan reduces taxable income immediately.
In other words, before income taxes are imposed, the contributions diminish an employee’s income for the tax year.
lndividual Retirement Account (IRA)
Individuals may also save by making contributions to a regular IRA (IRA).For the tax years 2021 and 2022, the yearly contribution limit to an IRA is $6,000, with a catch-up provision of $1,000 for persons 50 and over.
Traditional IRA contributions may be deducted from a person’s tax return, lowering taxes owing in the tax year in which the contribution is made. However, unlike contributions to an employer-sponsored plan, IRA contributions are made using after-tax earnings, which means that income taxes have already been deducted.
Taxpayers (or their spouses) who have employer-sponsored retirement plans may be eligible to deduct a portion or all of their standard IRA contributions from their taxable income. The IRS has specific criteria governing whether and how much they may deduct based on their income.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act was signed into law in December 2019. Taxpayers above the age of 7012 could not contribute to a regular IRA in 2019 or previous years. The age restriction will be lifted in 2020. Taxpayers above the age of 7012 may contribute up to $7,000 per year and still obtain the full tax advantage.
Consider Flexible Spending Plans
Some workplaces provide flexible spending accounts that enable money to be saved pretax for situations such as medical bills.
A flexible spending account (FSA) allows you to decrease your taxable income by putting a part of your wages into a separate account controlled by your employer. During the 2021 plan year, an employee may contribute up to $2,750 (and $2,850 in 2022).
Participating workers are sometimes required to incur qualified costs at the end of the plan year or forfeit unspent monies under the use-or-lose provision. Employers may grant participating workers more time via a carryover option or a grace period under a particular regulation (2.5 months).
An employee may carry over up to $550 of leftover money to the next plan year using the carryover option. An employee who chooses the grace period option gets until 2.5 months after the end of the plan year to incur qualified costs. Employers may provide any choice, but not both, or neither option at all.
As part of the Consolidated Appropriations Act, the IRS issued recommendations that gave businesses additional flexibility in benefit programs for 2020 and 2021. Employers may enable workers to carry over all unused money from 2020 to 2021 and 2021 to 2022, or they can prolong the grace period from 2.5 months to 12 months; in any case, all unused funds can be carried over and utilized throughout the year.
Health Savings Account (HSA)
A health savings account (HSA), like an FSA, permits pretax contributions to be utilized for future healthcare bills. Employees with high-deductible health insurance plans are the only ones who may use HSAs.
Minimum Annual Deductible
According to the IRS, a high deductible health plan includes a minimum annual deductible of $1,400 for self-only coverage or $2,800 for family coverage in 2021 and 2022.
Annual Contribution Limit
For 2021, the yearly contribution ceiling is $3,600 for individuals and $7,200 for families. The contribution ceiling for 2022, however, is $3,650 for individuals and $7,300 for families.
Maximum Annual Out-of-Pocket Expenses
In addition, under a high-deductible plan, yearly out-of-pocket expenditures (deductibles, co-payments, but not premiums) do not exceed $7,000 for self-only coverage or $14,000 for family coverage in 2021, but do not exceed $7,050 for self-only coverage or $14,100 for family coverage in 2022.
HSA contributions, unlike FSA balances, may be carried over if they are utilized in the year they were saved.
HSAs and FSAs both provide tax benefits throughout the years in which contributions are made.
Take Business Deductions
For full- or part-time self-employed individuals, a long number of deductions are available to reduce taxable income.
Home Office Deduction
If a section of a house is utilized as dedicated office space, a home office deduction is computed using either a simplified or standard approach to lower taxable income. To reduce taxable income, self-employed individuals may deduct a percentage of their self-employment tax and the cost of health insurance, among other costs.
Business owners and people with professional, deductible costs may make essential purchases or expenditures before the end of the fiscal year. This may make a major impact for customers purchasing a large item whose purchase price can be deducted from company costs.
Retirement Savings Plans
For the self-employed, there are many retirement savings plans available, including an individual 401(k) and a simplified employee pension (SEP) IRA. Both approaches provide for reduced taxable income via pre-tax contributions and allow for increased contribution limits each year.
In 2021, the SIMPLE IRA permits donations of up to $13,500, with an additional $3,000 for individuals 50 and over. In 2022, the sum increases to $14,000, plus the additional amount for individuals over the age of 50. Contributions to the Solo 401(k) are tax-free up to $19,500 in 2021 and $20,500 in 2022. The SEP-IRA provides for tax-deductible contributions of up to 25% of salary in 2021 and $61,000 in 2022.
The SECURE Act
Small company owners should be aware of the SECURE Act. The Act encourages company owners to set up retirement plans for their workers by offering tax breaks if they work with other small firms to form Multiple Employer Plans, or MEPs.
Starting in 2021, the SECURE Act will also enable more part-time workers to save via employer-sponsored retirement programs. Workers must put in at least 500 hours each year for three years in a row to be eligible.
The Bottom Line
For most taxpayers, tax reform removed numerous itemized deductions, but there are still ways to prepare for the future and reduce their current tax burden. Consult a tax professional to learn more about deductions and tax savings.
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