How to Strategically Pay Less in Taxes

Proactive tax planning is a year-round process of evaluating your financial situation to optimize tax outcomes. This approach contrasts with reactive planning, where decisions are rushed as filing deadlines approach, potentially leading to missed opportunities for savings.

Maximizing Tax Deductions

A tax deduction reduces the amount of your income that is subject to tax, which can lower your final bill. The Internal Revenue Service (IRS) allows taxpayers to lower their taxable income by taking either a standard deduction or by itemizing deductions. Choosing the more advantageous option is a yearly financial decision.

The standard deduction is a fixed dollar amount determined by your filing status, age, and whether you are blind. For the 2025 tax year, the standard deduction for a single individual is $15,000, and for married couples filing jointly, it is $30,000. Its benefit is simplicity, as it does not require extensive record-keeping.

Itemizing deductions involves tallying specific eligible expenses and is beneficial if your total expenses exceed the standard deduction. This process requires meticulous documentation, such as receipts and bank statements, for Schedule A (Form 1040). If you are married filing separately and your spouse itemizes, you are also required to itemize.

Mortgage Interest Deduction

The mortgage interest deduction allows homeowners to deduct the interest paid on a loan used to buy, build, or improve a primary or second home. You can deduct the interest on up to $750,000 of mortgage debt, or $375,000 if married filing separately. Your lender will send Form 1098, which details the amount of interest you paid. Payments toward the principal balance of the loan are not deductible, and the deduction is most impactful in the early years of a mortgage.

State and Local Taxes (SALT) Deduction

The State and Local Tax (SALT) deduction allows itemizing taxpayers to deduct certain taxes paid to state and local governments. These include property taxes and either income or sales taxes, but not both. The total amount you can claim for the SALT deduction is limited to $10,000 per household per year, or $5,000 if married filing separately. This cap is set to expire at the end of 2025 unless Congress acts to change it.

Charitable Contributions

Donations made to qualified charitable organizations can be claimed as an itemized deduction. The organization must be recognized as tax-exempt by the IRS, which you can verify on the IRS website. For cash contributions, the deduction is limited to 60% of your adjusted gross income (AGI), while donations of non-cash assets are limited to 30% of AGI.

For any donation under $250, you need a bank record or written acknowledgment from the charity. For contributions of $250 or more, a contemporaneous written acknowledgment from the organization is required. If you receive a benefit for your contribution, you must subtract its value from your deduction.

Medical Expense Deduction

You can deduct unreimbursed medical and dental expenses for yourself, your spouse, and your dependents, but only the amount that exceeds 7.5% of your adjusted gross income (AGI). For example, if your AGI is $100,000, you can only deduct medical expenses over $7,500. Qualifying expenses include payments to doctors and dentists, hospital care, prescription drugs, and health insurance premiums paid with after-tax dollars.

Utilizing Tax Credits

A tax credit is a dollar-for-dollar reduction of your tax liability, making it more impactful than a deduction, which only reduces your taxable income. Credits are designed to provide financial relief or incentivize specific behaviors.

Family-Related Credits

The Child Tax Credit is for taxpayers with qualifying children under age 17 who are claimed as dependents on your tax return. The credit amount and eligibility are subject to income limitations.

The Child and Dependent Care Credit helps offset care costs for a child under 13, or a dependent unable to care for themselves, allowing the taxpayer to work. The credit is a percentage of your work-related care expenses, and the percentage is based on your adjusted gross income.

Education Credits

The American Opportunity Tax Credit (AOTC) helps pay for the first four years of postsecondary education, with a maximum annual credit of $2,500 per student. To be eligible, the student must be pursuing a degree, be enrolled at least half-time, and not have finished their first four years of higher education.

The Lifetime Learning Credit (LLC) is for qualified tuition and related expenses for undergraduate, graduate, and professional degree courses. There is no limit on the number of years you can claim the credit. The LLC is a nonrefundable credit, meaning it can reduce your tax to zero, but you cannot get any of it back as a refund.

Leveraging Tax-Advantaged Accounts

Long-term financial planning using tax-advantaged accounts offers benefits through two primary mechanisms. Contributions can be tax-deductible, lowering current taxable income, or growth and withdrawals can be tax-free, providing future savings. Understanding these differences is part of building a tax-efficient savings plan.

Retirement Accounts

Retirement accounts are categorized as Traditional and Roth types. With a Traditional 401(k) or IRA, contributions are made with pre-tax dollars, lowering your current taxable income. Investments grow tax-deferred, and you pay income tax on withdrawals in retirement, which is beneficial for those expecting to be in a lower tax bracket then.

Conversely, Roth 401(k)s and IRAs are funded with after-tax dollars, so there is no immediate tax deduction. The benefit is that investments and qualified withdrawals in retirement are tax-free, which is advantageous for those anticipating a higher tax bracket in retirement.

Health Savings Accounts (HSAs)

A Health Savings Account (HSA) offers a triple tax advantage, but you must be enrolled in a high-deductible health plan (HDHP) to contribute. Contributions are tax-deductible, lowering your current taxable income. For 2025, the maximum contribution is $4,300 for self-only coverage and $8,550 for family coverage.

The funds within an HSA can be invested to grow tax-free, and withdrawals are also tax-free when used for qualified medical expenses. After age 65, unused funds can be withdrawn for any reason but will be subject to income tax if not used for medical costs.

Managing Investment Taxes

The tax implications of buying and selling assets like stocks can affect your overall financial returns. The two primary concepts for managing these taxes are understanding the different tax rates for capital gains and strategically realizing losses to offset those gains.

Capital Gains

When you sell an investment for a profit, it is a capital gain subject to tax. The tax rate depends on how long you held the asset. A short-term capital gain, from an asset held for one year or less, is taxed at your ordinary income tax rate.

A long-term capital gain, from an asset held for more than one year, is taxed at lower preferential rates. For most taxpayers, these rates are 0%, 15%, or 20%, depending on taxable income. This difference creates an incentive to hold profitable investments for more than a year before selling.

Tax-Loss Harvesting

Tax-loss harvesting is a strategy to reduce capital gains tax by selling investments that have decreased in value to realize a loss. These losses can offset capital gains. If your capital losses exceed your gains, you can use up to $3,000 of the excess to offset ordinary income each year.

The wash-sale rule prohibits you from claiming a loss if you buy a “substantially identical” security within 30 days before or after the sale. This 61-day window prevents investors from claiming a loss only to immediately restore their position.