With marginal tax rates of up to 37% in 2021, income taxes can have a significant effect on your financial situation. There are basically three strategies to help reduce your income tax bill:
1. Reduce or eliminate taxes. The objective is to receive income in a nontaxable form or to find additional tax deductions, exemptions, or credits. For instance, you might want to consider municipal bonds, whose interest income is generally not subject to federal, and sometimes state and local, income taxes. Investigate investments that generate capital gains, such as growth stocks. Gains are not taxed until you actually sell the investment, and if held for over one year, capital gains are subject to capital gains tax.
Under current tax law, you pay no more than 15% to the U.S. Treasury on long-term capital gains from selling investments held for over one year on amounts up to: $459,700 for singles, $517,200 for married joint-filing couples, $488,500 for heads of households in 2022 (in 2021 these figures were $445,850, $501,600, $473,750 respectively). (in 2021 these figures were $445,850, $501,600, $473,750 respectively). The same rate applies to qualified dividends.
Capital gains on investments held less than a year are short-term capital gains and taxed at ordinary income tax rates of 10, 12, 22, 24, 32, 35 and 37% in 2022 (and 2021).
If you have realized capital gains, you might want to offset those gains by selling investments with losses. Or consider investments that pay qualified dividends, which are taxed at capital gains tax rates.
2. Postpone the payment of income taxes until some time in the future. By postponing tax payments, your earnings compound on the entire balance, including the portion that will eventually be paid in taxes. You may also be in a lower tax bracket when taxes are paid. As an example, contribute as much as possible to retirement accounts, including employer plans and individual retirement accounts (IRAs).
3. Shift the tax burden to another individual. The objective of this technique is to transfer assets to other individuals so any income on those assets becomes taxable to those individuals, who may be in lower tax brackets. Typically, however, you must give up control of the asset. For instance, annually you can give tax-free gifts, up to $16,000 or $32,000 in 2022 (and 2021) if the gift is split with your spouse, to any number of individuals. Any future income generated on those gifts then becomes taxable to those individuals. You may also want to use your lifetime gift tax exclusion which rises to $12.06 million for 2022 (up from $11.70 million in 2021) to make larger gifts.
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