Common Tax Planning Examples Explained

Tax planning is the analysis and strategic structuring of a person’s financial affairs to legally minimize their tax liability. The process involves arranging finances in a way that aligns with the law to reduce the amount of tax owed, rather than illegally evading taxes.

Financial choices made throughout the year can impact an individual’s final tax bill. By applying various strategies, taxpayers can lower their taxable income or directly reduce the tax they owe. The following sections provide examples of tax planning techniques related to retirement savings, investments, and charitable giving.

This article is for informational purposes and is not professional tax or legal advice. Tax laws are complex and subject to change. You should consult with a qualified tax professional to understand how this information applies to your specific situation.

Examples for Reducing Taxable Income

One way to manage tax liability is by reducing taxable income through deductions, which lowers your adjusted gross income (AGI). Common strategies involve using tax-advantaged accounts for retirement and healthcare savings.

A primary example is maximizing contributions to pre-tax retirement accounts like a Traditional 401(k) or a deductible Traditional IRA. These contributions are subtracted from gross income for the year. For tax year 2025, an employee can contribute up to $23,500 to their 401(k).

For instance, an individual with a $115,000 taxable income is in the 24% federal tax bracket. By contributing the maximum $23,500 to their 401(k), they reduce their taxable income to $91,500, saving $5,640 in federal tax. Individuals age 50 and over can contribute an additional $7,500, further increasing their tax savings.

A Health Savings Account (HSA) also reduces taxable income. HSAs offer a triple tax advantage: contributions are tax-deductible, funds grow tax-free, and withdrawals for qualified medical expenses are tax-free. Eligibility requires enrollment in a high-deductible health plan (HDHP).

For 2025, a person with family HDHP coverage can contribute up to $8,550. A family in the 22% tax bracket contributing the maximum would lower their taxable income by that amount, saving $1,881 in federal income taxes while funding future medical needs.

Bunching itemized deductions is another strategy. Taxpayers can either take the standard deduction or itemize deductions, choosing whichever is larger. For 2025, the standard deduction for a married couple filing jointly is $30,700.

Many taxpayers find their annual itemized deductions—like state and local taxes (capped at $10,000), mortgage interest, and charitable giving—do not exceed this amount. The bunching strategy concentrates discretionary expenses into a single year to surpass the standard deduction threshold.

For example, a couple with $18,000 in taxes and interest could make two years’ worth of charitable donations ($16,000) in one year. Their itemized deductions would total $34,000, exceeding the standard deduction. In the following year, they would take the standard deduction, maximizing their deductions over the two-year period.

Examples for Utilizing Tax Credits

Unlike deductions that reduce taxable income, tax credits reduce a person’s final tax liability on a dollar-for-dollar basis. Some credits are refundable, meaning a taxpayer can receive the difference back as a refund if the credit is larger than the tax owed.

The Child Tax Credit (CTC) is a common example. For the 2025 tax year, the CTC is worth up to $2,000 for each qualifying child under 17. A married couple with two children and a $5,000 tax liability could receive a $4,000 credit, reducing their tax bill to $1,000.

The credit begins to phase out for joint filers with modified adjusted gross incomes over $400,000. A portion of the CTC is refundable through the Additional Child Tax Credit (ACTC), which is worth up to $1,700 per child for 2025.

The American Opportunity Tax Credit (AOTC) is for qualified education expenses for a student’s first four years of higher education. The credit is worth up to $2,500 per student. For example, a family paying $6,000 in tuition can claim the maximum $2,500 credit. Up to $1,000 of the AOTC is refundable.

Energy efficiency incentives also provide tax credits. The Residential Clean Energy Credit is for new, qualified property like solar panels. For property installed by 2032, the credit is 30% of the total cost with no upper limit.

A homeowner who spends $25,000 on a qualifying solar system can claim a $7,500 tax credit. Similarly, the Clean Vehicle Credit offers up to $7,500 for purchasing a qualifying new electric vehicle, subject to income and price limits.

Examples for Managing Investment Taxes

Tax planning for a taxable investment portfolio focuses on minimizing capital gains and other investment taxes. These strategies apply to assets managed in standard brokerage accounts and can preserve more of an investor’s returns.

Tax-loss harvesting involves selling an investment at a loss to offset capital gains from profitable investments. For example, a $4,000 loss can offset a $5,000 gain, meaning the investor only pays tax on a net gain of $1,000. If capital losses exceed gains, up to $3,000 of the excess can offset ordinary income annually.

Donating appreciated securities to a qualified charity is another effective technique. This strategy provides two tax benefits: the donor avoids paying capital gains tax on the asset’s appreciation, and they can claim a charitable deduction for the asset’s full fair market value.

Consider an individual who owns stock worth $10,000, originally purchased for $2,000. If they sell the stock and donate the cash, they must first pay capital gains tax on the $8,000 gain. By donating the stock directly, they avoid the capital gains tax and still receive a deduction for the full $10,000.

Asset location involves placing different types of investments in the most appropriate accounts to maximize after-tax returns. The principle is to hold tax-inefficient investments, which generate regular taxable income, inside tax-advantaged accounts like a 401(k) or IRA.

Conversely, tax-efficient investments are better suited for taxable brokerage accounts. For example, corporate bonds that generate regular interest are best placed in a tax-deferred account. Broad-market stock index funds, which generate returns mainly through price appreciation, can be held in a taxable account with less tax impact.

Examples for Business Owners and Self-Employed Individuals

Self-employed individuals and small business owners have access to tax planning opportunities that reduce taxable business income. These strategies help manage both income and self-employment tax liabilities.

A primary strategy is deducting all ordinary and necessary business expenses. For a consultant working from home, this includes a portion of home expenses via the home office deduction. This can be calculated using a simplified method or the actual expense method.

If they use a personal vehicle for business, they can deduct car expenses using the standard mileage rate (69 cents per mile for 2025). Other deductible costs include business software, professional development, and 50% of business meals. These deductions reduce net earnings subject to self-employment tax.

The choice of business structure has tax implications, especially for self-employment taxes. A sole proprietor pays self-employment tax on all net profit. An S Corporation can offer savings by allowing the owner to be treated as an employee.

The owner must pay themselves a “reasonable salary,” which is subject to FICA taxes. Any remaining profit can be taken as a distribution, which is not subject to self-employment taxes. For example, a consultant with $150,000 in net income could pay themselves a $70,000 salary, and the remaining $80,000 distribution would avoid self-employment tax.

Self-employed individuals can use retirement plans with higher contribution limits than standard IRAs, such as a Simplified Employee Pension (SEP) IRA or a Solo 401(k). For 2025, a self-employed person can contribute up to 20% of their net adjusted self-employment income to a SEP IRA, not to exceed $71,000.

A Solo 401(k) has the same overall limit but allows contributions as both an “employee” (up to $23,500 in 2025) and an “employer.” A sole proprietor with $100,000 in net income could contribute far more to these plans than the standard IRA limit.