How to Decrease Taxable Income: Proven Strategies

Taxable income is the portion of your gross income subject to taxation. It is calculated by subtracting eligible adjustments and deductions from your total earnings. This article explores legal strategies for individuals, investors, and business owners to lower their taxable income and the amount of tax they owe.

Reducing Income with Adjustments

Your Adjusted Gross Income (AGI) is your gross income minus specific “above-the-line” deductions. Lowering your AGI is important because it can increase your eligibility for other tax deductions and credits with income limitations. These adjustments are claimed on Schedule 1 of Form 1040.

A common adjustment is a contribution to a traditional Individual Retirement Arrangement (IRA). For 2025, you can contribute up to $7,000, or $8,000 if you are age 50 or older. The deductibility of these contributions depends on your income and whether you are covered by a retirement plan at work. For single filers covered by a workplace plan in 2025, the deduction phases out with a Modified Adjusted Gross Income (MAGI) between $79,000 and $89,000.

Contributions to a Health Savings Account (HSA) also reduce AGI. HSAs have a triple-tax advantage: contributions are tax-deductible, funds grow tax-free, and withdrawals for qualified medical expenses are tax-free. To be eligible, you must be enrolled in a high-deductible health plan (HDHP). For 2025, the contribution limit is $4,300 for self-only coverage and $8,550 for family coverage, with a $1,000 catch-up for those age 55 and older.

Another adjustment is the student loan interest deduction. Taxpayers can deduct up to $2,500 of interest paid during the year, even if they don’t itemize. For 2025, this deduction phases out for single filers with a MAGI between $85,000 and $100,000 and for joint filers with a MAGI between $170,000 and $200,000.

Self-employed individuals can also claim an adjustment. They can deduct one-half of what they pay in self-employment taxes, which covers both the employee and employer portions of Social Security and Medicare taxes. This deduction accounts for the employer’s share and reduces AGI.

Choosing Between the Standard or Itemized Deduction

After determining your AGI, you can reduce it further by taking either the standard deduction or by itemizing deductions. The standard deduction is a fixed dollar amount that varies by filing status. For the 2025 tax year, the standard deduction is $15,000 for single filers and $30,000 for married couples filing jointly.

If your total eligible expenses exceed your standard deduction, it may be better to itemize. Itemizing involves listing specific deductible expenses on Schedule A of Form 1040 and requires careful record-keeping.

Common itemized deductions include:

• State and local taxes (SALT), including income, sales, and property taxes. The total SALT deduction is capped at $10,000 per household per year.
• Mortgage interest on a primary residence and a second home. This is limited to the interest on up to $750,000 of mortgage debt.
• Charitable contributions of cash or property to qualified organizations. Cash contributions are deductible up to 60% of AGI, while non-cash donations are deducted at fair market value.
• Medical and dental expenses that exceed 7.5% of your AGI. This can include payments to doctors, hospitals, and costs for prescription drugs.

Using Tax Credits to Directly Cut Your Tax Bill

Unlike deductions, which lower your taxable income, tax credits reduce your tax liability on a dollar-for-dollar basis. A $1,000 credit cuts your tax bill by $1,000. Credits are categorized as non-refundable, which can only reduce your liability to zero, or refundable, which can result in a tax refund.

The Child Tax Credit is for families with qualifying children under age 17. For the 2025 tax year, this credit is worth up to $2,000 per child and is partially refundable. The credit begins to phase out at higher income levels.

Two credits can offset higher education expenses. The American Opportunity Tax Credit (AOTC) provides up to $2,500 per student for the first four years of higher education and is partially refundable. The Lifetime Learning Credit (LLC) offers up to $2,000 per tax return for undergraduate, graduate, and professional degree courses.

Clean vehicle credits are available for purchasing new and used electric vehicles (EVs). The amount of the non-refundable credit depends on the vehicle’s battery capacity, MSRP, and the buyer’s income. The eligibility rules for these credits are complex.

Tax Reduction Strategies for Investors

Investors can use several strategies to minimize the tax impact of their portfolio. These techniques focus on the timing of gains and losses and the type of account used for investments, which can enhance after-tax returns.

Tax-loss harvesting involves selling investments that have decreased in value to realize a capital loss. These losses can offset capital gains from other investments. If losses exceed gains, up to $3,000 of the excess can be used to offset ordinary income each year.

When harvesting losses, you must follow the “wash-sale rule.” This IRS regulation prevents claiming a loss if you buy a “substantially identical” security within 30 days before or after the sale. To avoid this, an investor must wait 31 days before repurchasing the same investment or buy a different but similar asset.

The tax rate on long-term capital gains, from assets held for more than one year, is lower than the rate for short-term gains. Short-term gains are taxed at higher ordinary income rates. Holding appreciated assets for at least a year and a day before selling is a fundamental tax-reduction strategy.

Asset location involves placing investments in the most tax-efficient accounts. For example, high-growth assets with favorable capital gains tax treatment might be held in a standard brokerage account. Assets that produce regular, highly-taxed income, like bonds, are often better placed in tax-deferred accounts like a 401(k) or IRA to grow without being taxed annually.

Deductions for the Self-Employed and Business Owners

Self-employed individuals and small business owners can claim several business-related deductions not available to employees. These deductions offset business costs and are claimed on Schedule C, Profit or Loss from Business, to lower taxable income.

The Qualified Business Income (QBI) deduction allows eligible owners of pass-through businesses, like sole proprietorships and partnerships, to deduct up to 20% of their qualified business income. This deduction is subject to limitations based on the taxpayer’s income and the type of business.

The home office deduction is for those who use a part of their home exclusively and regularly for business. You can calculate this using the simplified method, which is $5 per square foot up to 300 square feet. Alternatively, the actual expense method involves deducting a percentage of home costs like rent, utilities, and insurance.

Business owners can deduct vehicle expenses using one of two methods. The standard mileage rate involves multiplying business miles by a rate set by the IRS. The actual expense method requires tracking all vehicle-related costs, such as gas, insurance, and depreciation.

Business owners can also deduct other ordinary and necessary operating expenses. This includes costs for business travel, office supplies, software subscriptions, and business insurance premiums. Meticulous record-keeping is necessary to substantiate these claims.

Self-employed individuals can deduct premiums paid for their health insurance as an adjustment to income. They also have access to retirement plans with higher contribution limits than traditional IRAs, such as a SEP IRA or Solo 401(k). Contributions to these plans are deductible and allow for greater tax-deferred savings.