How to Get Into a Lower Tax Bracket

A tax bracket represents a specific range of taxable income that is subject to a particular tax rate. The United States employs a progressive tax system, meaning different portions of an individual’s income are taxed at varying rates, with higher income segments facing higher marginal rates. A marginal tax rate is the percentage of tax applied to each additional dollar of income within a specific tax bracket. The goal of strategic tax planning is to reduce one’s overall tax liability by minimizing the amount of income subject to taxation.

Leveraging Pre-Tax Contributions

Making pre-tax contributions to various accounts offers a direct method for reducing an individual’s adjusted gross income (AGI), which can effectively lower their taxable income and potentially move them into a lower tax bracket. These contributions are subtracted from gross income before taxes are calculated.

Employer-sponsored retirement plans like 401(k)s and 403(b)s allow employees to defer a portion of their salary before taxes are withheld. For 2024, the elective deferral limit for these plans is $23,000, with an additional catch-up contribution of $7,500 permitted for those aged 50 and over. Maximizing these contributions directly reduces current taxable income, as the money grows tax-deferred until retirement. Similarly, contributions to a Traditional Individual Retirement Account (IRA) can be tax-deductible, though eligibility for deductibility may depend on income levels and participation in an employer-sponsored retirement plan. For 2024, the IRA contribution limit is $7,000, with an extra $1,000 catch-up contribution for individuals aged 50 and older.

Health Savings Accounts (HSAs) provide another avenue for pre-tax savings, specifically for healthcare expenses. Contributions to an HSA are tax-deductible, and the funds grow tax-free and can be withdrawn tax-free for qualified medical expenses, offering a “triple tax advantage.” To be eligible, an individual must be covered by a high-deductible health plan (HDHP). For 2024, the contribution limit for self-only HDHP coverage is $4,150, and for family HDHP coverage, it is $8,300, with an additional $1,000 catch-up contribution for those aged 55 and over.

Flexible Spending Accounts (FSAs) also utilize pre-tax dollars for eligible healthcare or dependent care expenses, reducing an individual’s taxable income. These employer-sponsored accounts typically operate under a “use-it-or-lose-it” rule, meaning funds generally must be spent by the end of the plan year, though some plans allow for a grace period or a limited carryover. The annual limit for healthcare FSAs in 2024 is $3,200.

Optimizing Deductions

Optimizing deductions is a strategy to reduce taxable income, potentially allowing an individual to fall into a lower tax bracket. Deductions reduce the amount of income subject to tax after Adjusted Gross Income (AGI) has been calculated.

Taxpayers have the choice between taking the standard deduction or itemizing their deductions. The standard deduction is a fixed dollar amount based on filing status, such as $14,600 for single filers and $29,200 for married couples filing jointly in 2024. Itemized deductions, on the other hand, allow taxpayers to subtract specific eligible expenses. Individuals generally choose the larger of the two to maximize their tax savings.

Common itemized deductions can include state and local taxes (SALT), which are limited to a combined $10,000 per household for property, income, or sales taxes. Another itemized deduction is for mortgage interest paid on a home loan, applicable to interest on up to $750,000 of mortgage debt for loans originated after December 15, 2017. Charitable contributions also offer a deduction opportunity, with cash contributions to qualified organizations generally deductible up to 60% of AGI, while non-cash contributions may have different limits. Unreimbursed medical expenses exceeding 7.5% of an individual’s AGI can also be itemized.

Beyond itemized deductions, certain “above-the-line” deductions directly reduce AGI, providing a benefit regardless of whether one itemizes. These include the student loan interest deduction, which allows taxpayers to deduct up to $2,500 of interest paid on qualified student loans, subject to income limitations. Self-employed individuals can deduct one-half of their self-employment taxes. Additionally, eligible educators can deduct up to $300 for unreimbursed ordinary and necessary expenses paid for classroom supplies and professional development.

Strategic Income and Expense Management

Effective management of income and expenses across tax years can significantly influence an individual’s taxable income and, consequently, their tax bracket. These strategies involve timing financial events to optimize tax outcomes.

One strategy is tax-loss harvesting, which involves selling investments at a loss to offset capital gains. If capital losses exceed capital gains, up to $3,000 of the net loss can be used to reduce ordinary income annually, with any excess losses carried forward to future years.

Timing the recognition of income and the payment of expenses is another effective approach. Individuals may consider deferring income, such as bonuses or consulting fees, from the end of one tax year to the beginning of the next. Conversely, accelerating deductible expenses, such as paying property taxes or making charitable contributions before year-end, can increase deductions in the current year, thereby lowering taxable income.

Managing capital gains is also essential for overall tax planning. Short-term capital gains, derived from investments held for one year or less, are taxed at ordinary income tax rates. In contrast, long-term capital gains, from investments held for more than one year, are subject to lower preferential tax rates, such as 0%, 15%, or 20%, depending on the taxpayer’s overall taxable income. By holding investments for longer than a year, individuals can benefit from these lower rates.