Reducing Taxable Income

No reasonable person would prefer to make less money than more money. However, when the income tax bill comes due it can make one question, would they would be in better shape with less income? Fortunately, though, there are several effective ways to reduce taxable income without actually taking a pay cut.

To start, let’s answer the question, “what is taxable income“? In simple terms, taxable income is the amount of income that a person earns in a given year that is subject to being taxed. It is calculated by totaling a person’s income from all sources, then deducting tax-exempt income and tax deductions.

For most people, taxable income includes wages, salaries, qualified retirement plan distributions, and business income for those who are self-employed. Reducing taxable income, whether by electing tax-free income, deducting allowable expenses, or diverting savings into tax-advantaged vehicles, is a perfectly legitimate, legal way to reduce your tax bill. Let’s take a look at some of the most common and effective ways of reducing taxable income.

1. Retirement savings
Retirement savings are a major influencer of taxable income for people who are already retired, as well as those who are still saving for retirement.

For those saving for retirement, the tax treatment of retirement account contributions is important to understand. Contributions to traditional individual retirement accounts and 401k’s are tax-deductible in the year the contributions are made. This makes them a useful tool for those who need to reduce taxable income now. Keep in mind, however, that distributions from these types of accounts are taxable.

For those who may not need to minimize income now but anticipate a need to do so in retirement, Roth IRAs may be attractive. Roth IRA contributions are not tax-deductible, but earnings accrue on a tax-deferred basis, and distributions after age 59 ½ are completely tax-free. There is also no required minimum distribution at any age.