No one wants to send their hard-earned money to the IRS at tax time. Paying taxes is inevitable, however, there are some strategies to reduce your taxable income. During the past year, there was a major overhaul of the tax code in the United States with the passage of the Tax Cuts and Jobs Act of 2017. This act brought some changes to earners in all categories. Understanding these changes helps inform decisions about how to invest your money to maximize your retirement portfolio while minimizing your taxable income.
Tax Savings By Income Level
The Tax Cuts and Jobs Act resulted in significant shifts in federal income tax brackets. Although the Tax Cuts and Jobs Act should result in slight reductions in paid taxes for most households, regardless of income level, higher income earners in the 95th to 99th percentile received the largest share of cuts. To understand how the new laws might affect you, let’s take a look at some of the tax savings by income level. The information for this can be found in this report by the Tax Policy Center.
Although the Tax Cuts and Jobs Act has been much maligned in the media as predominantly benefiting the very wealthy, there are some substantial changes for middle-income earners. Households that are filing as Married, Filing Jointly (MFJ) will have a lower tax rate for their 2018 taxes. For couples filing MFJ that earn between $77,400 – 165,000, the new tax rate will be 22%, down from 25%. This rate also applies to single filers that earn between $38,700 – 82,500.
The highest federal income tax bracket experienced a relatively substantial reduction in tax rate. For couples filing as MFJ that earn over $600,000 annually, the tax rate was reduced from 39.6% to 37%. Some high-income earners experienced a shift in tax bracket as well. With the tax bracket restructuring, couples earning between $400,000 – 600,000 annually are now taxed at a rate of 35%. Under the prior year’s system, any couple earning over $480,000 per year was taxed at the rate of 39.6%. One primary concern for high-income earners in states like California and New York is the $10,000 annual SALT (state & local tax) deduction cap.
The lower income brackets also experienced shifts as a result of the Tax Cuts and Jobs Act. Households filing as MFJ making less than $77,400 had their tax rate reduced by 3%, from 15% to 12% in 2018. Families making less than $19,050 remained at the same tax rate, 10%, from 2017.
One other notable change that the Tax Cuts and Jobs Act brought about was a significant increase in the standard deduction. The standard deduction for single filers was raised to $12,000, MFJ filers now have a standard deduction of $24,000, and heads of household have a standard deduction of $18,000. This should help low and middle-income earners, while also simplifying the filing process for many Americans.
The Tax Cuts and Jobs Act introduced a 20% deduction for pass-through business entities. This pass-through self-employment tax deduction applies to sole proprietorships, S corporations, LLC’s, and partnerships. For MFJ filers earning less than $315,000, they are eligible to receive the full 20% tax deduction on their qualified business income. For MFJ filers with income greater than $415,000, there is no tax break or deduction for income. For MFJ filers between these two thresholds, deductions are limited and depend on the business type.
As outlined in our blog post, the tax changes for pass-through business entities is extremely complex. Although this may result in a reduction in business taxes paid by self-employed individuals, how much of a reduction will depend on a variety of factors unique to that individual, their earning levels, and in some cases their type of business.
Tax Savings Strategies
One of the most effective methods of reducing your taxable income is through retirement savings accounts, such as a 401(k) or other similar type employer plans. This is especially true for those that receive W-2 income and have other tax write-off options. Building out your retirement portfolio is an important step towards establishing financial security after you retire. Retirement plan contributions are heavily relied upon to help reduce taxable income for many Americans. Retirement accounts also account for the majority of capital income for middle-income Americans. Despite the strength of retirement accounts for producing measurable tax savings, many Americans fail to utilize them to their full extent. Some options to consider to reduce your taxable income are to maximize contributions to a retirement program matched or offered by your employer, such as a 401(k) or 403(b).
Business owners, aside from writing off business-related expenses, can take advantage of their position as an owner to help reduce their taxable income. Consulting with a knowledgeable financial planner, tax professional, and third-party administrator can result in the creation of a retirement plan that allows key employees, including the owner, to defer a substantial amount of income. Of course, there are many factors that go into this, including the number of employees and the salary of each. Nonetheless, it is usually always worth exploring.
Contributions to Health Savings Accounts (HSAs) are also deductible from your taxable income and can be accomplished through payroll deductions. Contributing to an HSA is an excellent method of reducing taxable income while also preparing for medical expenses after retirement. Another advantage that HSAs offer is that withdrawals are also tax-free for qualified medical expenses.
For further tax advice, talk to your CPA or contact Bull Oak Capital and we will be happy to help.
 Tax Policy Center, Analysis of the Tax Cuts and Jobs Act. https://www.taxpolicycenter.org/feature/analysis-tax-cuts-and-jobs-act
 Tax Policy Center, Effects of the Tax Cuts and Jobs Act: A Preliminary Analysis, pg. 4. https://www.brookings.edu/wp-content/uploads/2018/06/ES_20180608_tcja_summary_paper_final.pdf
 https://www.opm.gov/healthcare-insurance/healthcare/health-savings-accounts/health-savings-account/, https://www.irs.gov/pub/irs-pdf/p969.pdf