With tax season around the corner many individuals and small businesses may find themselves in a position where they are paying more in taxes than needed. In order to help inform and alleviate stress, I have compiled a list of a few tips that can be done to reduce taxable income. Before I begin, it is important to note the importance of keeping an eye on your Adjusted Gross Income (AGI) or your Modified Adjusted Gross Income (MAGI) because that is what determines how much you will pay in taxes. Keeping an eye on this number will help enhance decision making overall.
One popular method for reducing taxable income is maximizing the contributions to one's retirement plan because it is tax deductible. However, not all retirement plans are tax deductible. For example, with the Roth IRA, an individual must pay taxes for the contributions made, but does not have to pay taxes once the money is withdrawn. Even so, there are limitations to how much one can contribute to their retirement plan. As of 2022, 401(k) contribution limits for individuals are $20,500, or $27,000 if 50 or older.
An accountable plan is a plan that follows IRS regulations to reimburse workers for business expenses such as travel, entertainment, and tools. The reimbursements are not treated as income because the business deducts the expenses; therefore, they are not subject to withholding taxes or W-2 reporting. Thus, saving the company potential company employment taxes and lowering taxable income.
Claim Immediate Depreciation for Purchased Fixed Assets
By claiming a portion of recently purchased assets, taxable income can be reduced in the current year because net profit decreases as claimed depreciation increases. Furthermore, it is crucial to adjust the value of recently purchased assets that are listed in the books.
Delay Billing Done at the End of the Year
Billing for unpaid work done at the end of the year can be delayed to the following year until payment is received if the business uses cash basis accounting. This will reduce the total amount of tax owed at the end of the period. However it is important to not defer income if there are doubts concerning the customer's ability to pay and if the company is experiencing a cash shortfall.
Abandoning vs Selling Property
In certain situations it is more beneficial to abandon a property of no value to the business in comparison to selling the property for a nominal value. Abandoning the property could be a better option because it is fully deductible than to sell the property for a capital loss which is subject to limitations. This would be a good option to discuss with your accountant.
Charitable contributions are another popular way to reduce taxable income. More often than not, cash contributions can be deducted on Schedule A as an itemized deduction, but it is limited to usually 60% of the adjusted gross income. However, qualified donations can be deducted for up to 100% of the taxpayer’s adjusted gross income. Specifically for corporations, qualified contributions can be deducted for up to 25% of their taxable income. If donations exceed that amount, the amount can be carried over to the next tax year. In order to qualify, a contribution must be a cash contribution, made to a qualifying organization, and made during the calendar year.
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Vivianna De La Torre works at Thaddeus Resource Center as an Accounting Intern to support the mission to inspire and empower women. She is currently a student at the University of La Verne majoring in Accounting. Additionally, she aspires to become an Accountant and pass the CPA exam.