Big Tax Bill? Proactive Strategies to Minimize Your Future Tax Burden
As the saying goes, there are only two certainties in life: death and taxes. According to the IRS, in fiscal year 2023, the agency collected nearly $4.7 trillion in gross taxes, processed 271 million tax returns and other forms, and issued about $659 billion in refunds. With such a vast sum collected, chances are many taxpayers faced significant tax bills. Even though taxes cannot be avoided, there are strategies to help you manage your tax liability come mid-April each year.
Reduce Your Taxable Income with Pre-Tax Contributions
For working taxpayers, there are several different strategies to lower your adjusted gross income. Many employers offer retirement plans like 401(k)s, where contributions are made on a pre-tax basis. This reduces your taxable wages (shown on your W-2) by the amount contributed. In 2024, the maximum pre-tax contribution for individuals under 50 is $23,000. Those turning 50 by Dec. 31, 2024 can make an additional “catch-up contribution” of $7,500, which brings the total allowed to $30,500.
Health Savings Accounts (HSAs)
HSAs incentivize saving for qualified medical expenses with tax benefits. Contributions are pre-tax, and any investment growth within the account is tax-free if used for eligible expenses like dental care, doctor visits, and over-the-counter medications (see a full list at hsabank.com).
To qualify for an HSA, you must be covered under a High Deductible Health Plan (HDHP), not have other health coverage like a health plan with a spouse or family member, not be enrolled in Medicare, and not be claimed as a dependent on another’s tax return. In 2024, contribution limits are $4,150 for single filers and $8,300 for married couples filing jointly.
Traditional IRAs
Traditional IRAs allow pre-tax contributions for retirement savings. To be eligible, you must have “earned income” as defined by the IRS. Contribution limits are $7,000 for individuals under 50, with a $1,000 “catch-up contribution” allowed for those 50 or older in 2024.
Eligibility for Tax-Deductible Contributions
To be eligible to make tax-deductible contributions to a traditional IRA, there are some specific conditions that need to be met. You must first determine if you’re eligible for an employer-sponsored retirement plan like a 401(k). If so, different guidelines and contribution limits apply.
Impact of Employer-Sponsored Plans on IRA Deductions
If you participate in an employer-sponsored retirement plan, your deduction for traditional IRA contributions may be limited or eliminated if your income exceeds certain thresholds.
In 2024, single filers with employer-sponsored retirement plans and a modified adjusted gross income (MAGI) below $77,000 can deduct the full amount contributed (up to $7,000). A partial deduction is allowed on a single filer’s contributions to a traditional IRA if their MAGI falls between $77,000 and $87,000. If your MAGI exceeds $87,000, none of your contribution to a traditional IRA is deductible. Individuals NOT covered by an employer retirement plan can deduct their entire traditional IRA contribution.
Important Note
There are additional factors to consider before making any decisions around the strategies listed above. Please consult a tax advisor or financial professional to see if they may make sense for your unique situation.
Sources:
SOI Tax Stats – IRS Data Book
Publication 969 (2023), Health Savings Accounts and Other Tax-Favored Health Plans
HSA, HRA, Healthcare FSA and Dependent Care Eligibility List
Earned Income and Earned Income Tax Credit (EITC) Tables
Modified Adjusted Gross Income (MAGI): Calculating and Using It
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