Tax Planning: Benefits of Lowering Adjusted Gross Income

Renner Individual News; December 16, 2021

Taking steps to reduce your taxable income can reduce your overall tax burden. Individual taxpayers may be able to reduce their taxable income through deductions if they meet the qualifications and income limitations. Saving for retirement and future medical costs is an important way for an individual to achieve financial security and to prepare for future expenses. You can enjoy the tax benefits of reducing adjusted gross income by contributing to a retirement plan or a health savings account, or by exploring the opportunities for a student loan interest deduction.

Retirement Plans

Traditional IRA

Any individual with earned income, regardless of whether or not covered under other qualified retirement plans, can establish an individual retirement account (IRA). Traditional IRAs allow an individual with earned income to make tax-deductible or non-deductible contribution to a savings plan under which the gains and earnings are not taxed until they are distributed. Whether an individual is employed or self-employed, he or she may also take advantage of a variety of employer-sponsored retirement plans. These options not only provide security for the future, but also may provide opportunities for current tax savings.

Contributions to a traditional IRA are generally deductible on the taxpayer’s individual income tax return, to the extent that they do not exceed the lesser of the individual’s compensation for the year or the maximum contribution limit for the year, subject to income limits and participation in an employer-sponsored plan. In addition, nondeductible contributions from after-tax income may be made to traditional IRAs. For 2021, total contributions to all of a taxpayer’s traditional and Roth IRAs cannot be more than the lesser of $6,000 ($7,000 if he or she is age 50 or older) or his or her taxable compensation for the year. The amounts remain unchanged for 2022. Prior to 2020, an individual was not eligible to make contributions to a traditional or ROTH IRA after the age of 70½. The SECURE ACT removed this age limit.

SEP Plan

A SEP is a type of IRA for small business owners or self-employed individuals. A SEP IRA allows the employer to make contributions to the accounts set up for employees. Self-employed individuals choosing a SEP must include all employees who satisfy the following requirements: at least 21 years old; was employed during any three of the preceding five years; and earned at least $650 in the current year.

Contributions to a SEP plan are tax-deductible and earnings are not taxable until withdrawal. One advantage of the SEP IRA is the higher contribution limit. For 2021, employers can contribute the lesser of up to 25% of income (limited to $290,000) or $58,000. For 2022, the amount is the lesser of up to 25% of income or $61,000.

SIMPLE Plan

Any employer that had no more than 100 employees with $5,000 or more in compensation during the preceding calendar year can establish a SIMPLE IRA plan. Self-employed individuals who received earned income from the taxpayer and leased employees are taken into account for purposes of the 100-employee limitation.

Employers must also make contributions whether or not an employee elects to defer a portion of their income to the plan. Contributions are tax deductible and investments grow tax deferred until the owner is ready to make withdrawals in retirement. For 2021, an employee may defer up to $13,500. If the individual is age 50 or older, there is a $3,000 catch-up contribution allowed, for a total of $16,500. For 2022, the maximum employee deferral is $14,000 with a catch-up of $3,000.

Health Savings Account

Health savings accounts (HSAs) are available for individuals who have a high deductible health plan and may be funded by the individual or the individual’s employer. The benefits of an HSA include:

Taxpayers can claim a tax deduction for contributions you or someone other than your employer make to your HSA,

Contributions to your HSA made by your employer may be excludable from income,

The contributions remain in your account until you use them, and

The funds do not need to be spent in the current year.

For 2021, the maximum contribution to an HSA is the lesser of: the annual deductible under the individual’s high deductible health plan; or $3,600 for an individual with self-only coverage and $7,200 for an individual with family coverage. For 2022, the amounts are $3,650 and $7,300. Both years have a catch-up contribution of $1,000 for individuals age 55 or older.

Student Loan Interest Deduction

Interest paid by an individual taxpayer during the tax year on any qualified education loan is deductible from gross income in calculating adjusted gross income. The student loan must be incurred by the taxpayer solely to pay qualified higher education expenses. The maximum deductible amount of interest is $2,500, but the deduction is phased out or reduced based on the taxpayer’s modified adjusted gross income.

The SECURE Act now enables many borrowers to use a 529 to pay student loans. If your state allows, you can withdraw up to $10,000 from your 529 account to repay federal or private student loan debt. This $10,000 is a lifetime limit, but applies per plan beneficiary.

A taxpayer may contribute to a 529 plan. Many states allow a tax credit or deduction for the contribution. The funds are withdrawn to pay the student loan. If 529 funds are used to pay student loans, there is no tax deduction for the student loan interest. We would like to evaluate the tax advantages of retirement plans, health savings accounts or education benefits that could apply to your individual income tax situation. Please call us at your earliest convenience to review potential opportunities for you to reduce your taxable income or tax liability.

Renner & Company Can Help with Your Individual Accounting

Renner & Company provides full-service accounting to fit individual accounting needs. Contact us today and schedule a meeting to learn how Renner & Company can help, or call 703.535.1200.