How to Lower Your Taxable Income and Pay Less in Taxes
If you’re wondering how to pay less in taxes, you’re not alone. Everyone—from individuals to business owners—wants to know how to lower their taxes.
Tax laws are complicated and they can change each year. Our tax accountants know all the tax breaks for business owners and how to leverage them. With some guidance, you can legally reduce your tax liability and avoid paying more than you owe.
In this guide, we’ll go over how to lower taxable income and keep more of your profits while staying on the right side of the IRS. We’ll also share 12 tax-saving strategies, including a detailed explanation of each and how to determine if you qualify.
Table of contents
- Tax filing status: How businesses file taxes
- How much do Americans pay in taxes?
- What is taxable income?
- How to pay less in taxes: 12 tips
Tax filing status: How businesses file taxes
Business owners are responsible for filing taxes for their personal income as well as business income. You can file these together or separately, depending on what type of business you own.
For example, if you own a C corporation, you’ll file business and personal taxes separately. However, if you run an LLC not taxed as a corporation, you’ll pay taxes as a pass-through entity.
- The IRS taxes a regular corporation—or C corporation—as a separate entity. The corporation uses Form 1120 to report income and claim credits and deductions each year.
- A pass-through entity doesn’t file taxes as a separate entity. Instead, the income “passes through” to the owner of the business who pays personal income taxes on their share of the business.
The majority (95%) of businesses are pass-through entities. Below, we’ll cover how you can pay less in taxes on your business and personal income as a pass-through entity.
How much do Americans pay in taxes?
You pay taxes as a percentage of your income. There are seven tax brackets in the US tax code, ranging from 10% to 37%. Everyone’s tax situation is different.
There’s no one average tax bill, but the latest reports claim the average income tax payment in 2020 was $16,615. Thankfully, this amount isn’t paid all at once. Business owners pay estimated taxes quarterly, while employees pay a portion with every paycheck.
It’s worth noting, however, that most people don’t pay that much. In 2020, Americans in the most common tax bracket—incomes between $50,000 and $75,000—paid an average of $4,567 in income tax.
You pay a higher percentage of your income in taxes as your adjusted gross income (AGI) increases. Your AGI is the amount of your income that’s taxable after you subtract credits and deductions.
You can drastically reduce your tax bill by taking advantage of all your business tax credits and deductions.
What is taxable income?
Taxable income is the amount of income that the IRS uses to calculate how much you owe in taxes each year. It includes earned income from your business or wages from a job. Also, it includes unearned income, such as interest from investments. Some important concepts to keep in mind regarding taxable income:
- Tax deductions lower your taxable income, which can land you in a lower tax bracket. If your taxable income drops to a lower tax bracket, the IRS could tax you at a lower rate.
- Revenue – deductions = taxable income
- Tax credits reduce your tax bill dollar for dollar. If your tax liability is $2,000, but you qualify for a $1,000 tax credit, you’ll only owe $1,000.
Deductions and credits should be part of your overall tax-reduction strategy. We’ll go over both and suggest ways you can maximize them.
12 tips on how to pay less in taxes
One benefit of working with Xendoo’s experienced tax specialists and CPAs is that we know how to save you money on taxes legally. Most tactics that can lower your tax bill fall into three categories.
- Investment strategies or losses
We’ll break down each of these and show you how to lower your taxable income to pay less in taxes.
1. Pass-through tax deduction (QBI)
Congress passed the Qualified Business Income (QBI) deduction as part of the Tax Cuts and Jobs Act. It’s commonly known as the pass-through tax deduction and will end after the 2025 tax year. With the pass-through tax deduction, you can deduct up to 20% of your business income from a pass-through entity.
Your overall business income or loss determines the pass-through deduction. If you have several businesses and an overall loss, you can’t claim it. This is true even if one or more of your businesses was profitable.
Finally, you have to have taxable income to qualify. If the standard deduction or other deductions reduce your tax liability to zero, you won’t be able to claim it.
There are also income limitations on “specified service” businesses, such as doctors and lawyers—who are likely highly paid and self-employed. If your income comes from one of the specified services, you still qualify for the pass-through deduction. However, it starts phasing out at $321,400 for married filing jointly or $160,700 for other filers. If your income is over $260,700 ($421,400 joint), the pass-through deduction decreases.
The pass-through deduction can be complicated. (The IRS has 248 pages of guidance on it.) However, if you qualify, it can significantly lower your taxable income—at least through 2025.
2. Charity donations
As a pass-through entity, you’ll claim charity donations on your Form 1040—your individual return. You must make charitable donations to an organization that the IRS recognizes.
Your total charitable donations can’t be more than 60% of your AGI, including your business income. Some charities have lower limits. These are explained in the IRS Deductibility Status Codes.
If you exceed this amount, you can carry over deductions for up to five years. Keep a record of your donation for documentation. You’ll need additional documentation for the below.
- Donations of cash or property worth over $250 require a letter of acknowledgment from the charity.
- Non-cash donations of $500 or more require you to fill out Form 8283. You’ll also need an appraisal if your total donations exceed $5,000.
You can’t deduct the value of your volunteer time or services. However, you can deduct expenses related to volunteering like travel and mileage.
3. Business expense write-offs
You can deduct expenses related to running your business. Most business owners don’t claim all these expenses, either because they don’t know about them or they don’t keep records. Some common business expense deductions include:
- Employee wages and benefits
- Contract labor
- Equipment purchases
- Business insurance
- Bank fees
- Car expenses
- Travel expenses
- Rent expenses
- Education and training
- Marketing expenses
- Home office and office supplies
You can find details on each of these in our comprehensive list of small business tax deductions.
4. Vehicle costs
If you use your vehicle for business purposes, you can deduct its expenses. You may also be able to deduct the cost of a company vehicle.
You’ll use either the accrual or standard mileage rate to determine the deduction amount. The standard mileage for 2022 is 58.5 cents per mile for the first half of the year. It’s 62.5 cents per mile for the second half of the year. The standard mileage rate is more beneficial if your car gets good gas mileage and has low operating expenses.
To figure out your mileage deduction, keep track of the miles that you drive for business purposes. You’ll also need to provide the total miles you drove the car. If you take the standard mileage, you can still deduct auto loan interest, vehicle taxes and fees, and parking and toll expenses.
Your other option is to deduct the actual expenses. This includes auto-related expenses such as:
- Garage fees
You’ll need to keep track of your actual expenses and how many miles you drove the car. Calculate the business-related mileage by dividing the business miles by the total miles. Once you figure out the business-related mileage, deduct a corresponding percentage of actual costs.
If you buy an electric vehicle, you can also qualify for the electric vehicle tax credit—up to $7,500. However, that’s a separate credit, not a deduction.
Business equipment will lose its value over time as you use it. You can deduct the depreciation, although there are limits. You can use one of several methods to claim depreciation:
- Section 179 deduction – gives you a large deduction for the first year’s depreciation. For 2022, the deduction limit is $1,080,000.
- Bonus depreciation – deducts a larger amount of the purchase price for new vehicles and equipment. The Tax Cuts and Jobs Act increased the bonus deduction to 100% for 2022, but it will decrease each year. In 2023, it will be 80%, 60% the next year, and so on.
- Modified Accelerated Cost Recovery System (MACRS) depreciation – deduct more depreciation during the early years you own an asset and a smaller amount in the later years.
- Business vehicle deduction – deduct up to $10,200, plus up to $8,000 in bonus depreciation. For an SUV (between 6,000 to 14,000 pounds), you can deduct the entire cost of the vehicle the year you buy it using bonus depreciation.
6. Business startup costs
You can claim a deduction for the costs of starting your business. This deduction is capped at $5,000 for the first year if your total startup costs were under $50,000.
If your expenses were over $50,000, reduce the amount you deduct by the amount over $50,000. If your startup costs were over $55,000, you don’t qualify for a first-year deduction.
Instead, you’ll need to spread out your expenses and claim them starting in your second year for 15 years. If you anticipate a loss in your first year, it may be better to break up your startup costs and use them to offset profits in later years.
7. IRA contributions
There are several different types of IRAs, and they all offer tax advantages—although not all contributions are tax deductible.
SEP IRAs are ideal if you’re self-employed or don’t have employees. They have much higher contribution caps than traditional IRAs—either $66,000 or 25% of total compensation, whichever is less. However, if you set up a SEP IRA for yourself, you also have to set up and fund one for all eligible employees for an equal percentage. Contributions to a SEP IRA are tax deductible.
A SIMPLE IRA is a good option if your business has no more than 100 employees who earned at least $5,000 in the past year. Unlike SEP IRAs, employees can also contribute to SIMPLE IRAs. The SIMPLE IRA contribution limits are $1,400 for 2022 and contributions are tax deductible.
The contributions you make to a Roth IRA are not deductible. However, since you’ve already paid taxes on the money, you won’t have to pay taxes when you withdraw it. There are no penalties for early withdrawal.
If you think you’ll be in a higher tax bracket when you retire, a Roth IRA can be the better option. As long as your income is less than $129,000 ($204,000 joint), you can open an IRA. You can contribute up to $6,000 (or $7,000 if you’re over 50) for 2022. However, you won’t be able to contribute as much if your income is higher than $129,000 ($204,000 joint).
|SEP IRAs||SIMPLE IRA||Roth IRA|
|2022 contribution limits||$66,000 or 25% of total compensation||$1,400||$6,000
$7,000 for those over 50
|Are contributions tax deductible?||Yes||Yes||No|
|Who’s it a good fit for?||You’re self-employed or don’t have employees||Your business has no more than 100 employees||You’ll be in a higher tax bracket when you retire|
8. Health insurance plan deductions
If you’re self-employed, you may be able to deduct insurance premiums for your family, including:
- Long-term care
Even if you take the standard deduction, you can still deduct insurance premiums. However, you can only claim this deduction if you or your spouse were not eligible for an employer-sponsored plan. You also need a net income to claim this deduction.
If your small business offers health insurance to employees, you can also deduct the amount you contribute to their insurance premiums. It’s more complicated for partners and 2% S corporation shareholders, but you can still deduct health insurance premium contributions.
9. HSA contributions
An HSA is a health savings account you can use to pay for qualifying medical costs. You’re only eligible for an HSA if you have a high-deductible insurance plan. Your contributions are tax-deductible, and the earnings and qualified withdrawals are tax-free.
The maximum amount you can contribute for 2022 is $3,650 for yourself or $7,300 for your family. For 2023, the amounts increase to $3,850 for yourself and $7,750 for your family. The limits change yearly based on inflation. If you’re over 55, the limits are $1,000 higher.
|2022 Tax Year Limits||Single Plan||Family Plan|
|Max Contribution Limit||$3,650||$7,300|
|Over 55 Catch-up||$1,000||$1,000|
For retirement plans, don’t contribute more than the limit. Otherwise, you’ll lose the tax benefits, and you may have to pay a 6% penalty. Also, you have until next year’s tax deadline to make contributions, so you can deduct contributions for 2022 until April 2023.
To claim a deduction for your HSA account, you don’t have to itemize it but you must have income. HSAs are one of the more complicated deductions. Below is guidance for different tax situations. If you’re unsure, consult one of our licensed tax CPAs.
- Business owners or sole proprietors – you can’t contribute to an HSA with your pre-tax dollars. However, you can contribute with your after-tax money and deduct your contributions from personal income tax.
- LLCs with employees – you can make pre-tax contributions to an HSA. You can also deduct any contributions you make to their HSAs. If your business is an S corporation, the business can’t provide owners with tax-free contributions to HSAs.
- C corporations – the IRS taxes corporations as legal entities. For HSAs, it treats owners the same as employees. However, all contributions must still comply with IRS rules for employer contributions.
10. Tax-loss harvesting
You can use losses on capital investments to offset capital gains taxes. The capital gains tax is what you pay when you sell an asset for a profit.
Tax-loss harvesting is a year-end strategy to lower your tax bill. You’ll need to sell an asset at a loss to claim this deduction.
If your losses exceed your gains, you can deduct up to $3,000 from your personal income. You can claim losses over $3,000 in future years. But, don’t purchase a similar investment within 30 days—before or after—a loss. If you do, you can’t claim it. This is called a “wash sale.”
11. Student loan interest
You can deduct up to $2,500 of student loan interest if your MAGI is less than $70,000 or $145,000 filing jointly. Your MAGI is your AGI plus any untaxed foreign income, non-taxable Social Security benefits, and tax-exempt interest. Student loans you took out for your spouse, dependents, or yourself qualify.
If your MAGI is between $70,000 and $85,000 ($175,000 filing jointly), you can still claim some interest. However, you can’t claim the entire $2,500. Here’s a breakdown of the credit amounts depending on your filing status.
|Maximum credit amount||$2,500|
|Single, head of household income (MAGI) limit||Less than $70,000 – eligible for the full amount
$70,000- $85,000 – partial credit
|Married filing jointly income (MAGI) limit||Less than $145,000 – eligible for the full amount
$145,000-$175,000 – partial credit
This deduction is “above the line,” which means you subtract it from your taxable income. You can claim it even if you take the standard deduction. But, you can’t take the student loan interest deduction if:
- Your filing status is married filing separately
- Someone claims you as a dependent
- You’re not legally obligated to repay the loan
12. Higher education costs (for yourself or children)
If you’re paying for college for yourself or your children, you may be eligible for either the American opportunity tax credit (AOTC) or the lifetime learning credit.
The American opportunity tax credit is worth more but has stricter rules for qualification. If you qualify, you can claim a $2,500 tax credit. The full credit is available if your modified adjusted gross income (MAGI) is $80,000 or less for single filers or $160,000 or less for joint filers.
If your MAGI is between $80,000-$90,000 ($180,000 for joint filers), you can get a partial credit. Taxpayers can use the American opportunity tax credit for:
- Undergraduate education
- A maximum of four years
- Independent students
- Parents claiming dependent students
You can claim up to 20% of the first $10,000 you pay in tuition and fees when you claim the lifetime learning credit. It’s available for undergraduate, graduate, or vocational credits. There’s also no limit on how many years you can claim it.
However, you can’t claim both credits in the same year. You can claim the lifetime learning credit if your MAGI is less than $59,000 ($118,000 for joint filers). If your MAGI was over $59,000 but under $69,000 ($138,000 for joint filers), you can get partial credit.
Here’s a comparison of credit amounts and income limits to decide which will reduce your taxes the most.
|American opportunity tax credit||Lifetime learning credit|
|Maximum credit amount||Up to $2,500 credit per eligible student||Up to $2,000 credit per return|
|Single, head of household income (MAGI) limit||Full amount – $80,000 or less to claim the full amount
Over $80,000 and under $90,000 for partial credit
|$80,000 or less to claim the full amount
Over $80,000 and under $90,000 for partial credit
|Married filing jointly income (MAGI) limit||$160,000 or less to claim the full amount
Over $160,000 and under $180,000 for partial credit
|$160,000 or less to claim the full amount
Over $160,000 and under $180,000 for partial credit
How to pay less taxes with Xendoo
Xendoo’s experienced, licensed CPAs and tax professionals do more than file your taxes for you. Unlike some other bookkeeping and business tax services that outsource tax preparation and filing, we do it all in-house. We assess your unique tax situation and identify all the ways that you can lower your taxable income and pay less in taxes. Reach out today for a consultation.