Strategies for Minimizing Taxable Income and Maximizing Deductions
Understanding the TCJA and Its Ongoing Impact
Although the Tax Cuts and Jobs Act (TCJA) was enacted in 2017, it continues to influence tax planning today. The TCJA lowered rates across most individual income tax brackets, except for the 10% and 35% brackets, which remained unchanged. It also adjusted the income ranges for each bracket. These rates apply to âordinary income,â encompassing salary, self-employment or business income, interest, and distributions from tax-deferred retirement accounts.
In addition to income tax, itâs important to account for other taxes like the alternative minimum tax (AMT), which received some relief under the TCJA, and payroll taxes, which remained largely unaffected.
Deductions play a key role in reducing taxable income. They lower the portion of your income subject to federal (and often state) taxes. While the TCJA expanded some deductions, it reduced or eliminated others, creating new planning challenges. Income-based phaseouts and other limitations can further diminish the value of certain deductions, effectively increasing your marginal tax rate.
Adding complexity, many provisions of the TCJA are set to expire at the end of 2025. For instance, unless extended by Congress, tax rates and brackets will revert to pre-TCJA levels (adjusted for inflation) starting in 2026.
Standard vs. Itemized Deductions
Taxpayers can either itemize deductions on Schedule A or claim the standard deduction, which varies by filing status. Itemizing is worthwhile when your deductions exceed the standard deduction, though it involves more complex filing.
The TCJA nearly doubled the standard deduction, and these amounts are indexed for inflation through 2025. However, after 2025, the standard deduction is set to revert to pre-TCJA levels. The higher standard deduction and the reduction or elimination of many itemized deductions mean fewer taxpayers have found it advantageous to itemize. But if the current standard deduction expires in 2026, itemizing may again benefit a larger number of taxpayers.
Optimizing the Timing of Income and Expenses
Effective timing of income and expenses can significantly lower your tax liability, while poor timing can increase it.
Deferring Income and Accelerating Expenses: If you donât anticipate being subject to the AMT this year or next, deferring income to the following year and accelerating deductible expenses into the current year can be advantageous. This strategy defers taxes, which generally provides a financial benefit.
Accelerating Income and Deferring Expenses: When you expect to be in a higher tax bracket next year or believe tax rates will rise, the reverse strategy may be better. Accelerating income ensures itâs taxed at the current yearâs lower rate, while deferring expenses increases their value in a higher-tax-rate environment.
Here are some income items you may be able to control:
Bonuses
Self-employment income
U.S. Treasury bill income
Retirement plan distributions (if not subject to early-withdrawal penalties or required minimum distributions).
Potentially controllable expenses include:
Investment interest expense
Mortgage interest
Charitable contributions
By carefully managing the timing of these items, you can optimize your tax position and potentially save a significant amount.
TCJAâs Impact on Timing Strategies
The Tax Cuts and Jobs Act (TCJA) has made income and deduction timing more complex, as many strategies that once worked no longer provide the same benefits. Below is an overview of key changes affecting deductions:
Reduced SALT Deduction
The TCJA capped the state and local tax (SALT) deduction at $10,000 ($5,000 for married individuals filing separately). This has significantly impacted taxpayers with high state and local income or property taxes, reducing the benefits of timing property tax payments.
Current Impact: Many taxpayers no longer benefit from timing property tax payments under the SALT limit.
Future Considerations: The SALT cap is set to expire after 2025. Congress could let it expire, extend it, or adjust the limit.
How SALT Deductions Work:
You can deduct either state and local income taxes or sales taxes as part of the SALT deduction:
Income Taxes: Generally more beneficial for most taxpayers.
Sales Taxes: Often more advantageous for residents of states with low or no income tax or those making major purchases like a car or boat.
For sales tax, you donât need to track receipts for the entire year. Instead, the IRS provides a sales tax calculator based on your income, local rates, and any significant purchases.
Suspension of Miscellaneous Itemized Deductions
The TCJA suspended deductions subject to the 2% of adjusted gross income (AGI) floor through 2025. These include:
Professional fees,
Investment expenses, and
Unreimbursed employee business expenses (e.g., home office expenses for employees).
Self-Employed Exception: Self-employed individuals may still deduct home office expenses.
Future Considerations: Congress may allow this suspension to expire, extend it, or modify the rules.
Personal Casualty and Theft Loss Deduction
This deduction is now limited to losses resulting from federally declared disasters. Non-disaster-related casualty losses can only offset casualty gains (insurance reimbursements exceeding property costs or adjusted basis).
Future Outlook: The suspension is scheduled to expire after 2025 but may be extended.
Medical Expense Deduction
Taxpayers may deduct unreimbursed medical expenses exceeding 7.5% of AGI. This threshold can be difficult to surpass, but certain strategies may help:
Eligible Expenses: Health insurance premiums, long-term care insurance premiums (subject to limits), medical and dental services, prescription drugs, and mileage.
Bunching Strategy: Consolidating medical expenses into a single year may help exceed the AGI floor, especially when combined with other itemized deductions.
Filing Separately for Medical Expenses:
If one spouse has high medical costs and a lower AGI, filing separately could allow them to exceed the 7.5% threshold. However, this approach could trigger the alternative minimum tax (AMT) due to lower exemptions for separate filers.
Health Savings Accounts (HSAs) and Flexible Spending Accounts (FSAs)
You can avoid the medical expense deduction floor by contributing to tax-advantaged accounts:
HSA:
Available if covered by a high-deductible health plan.
Contribution limits apply, with an additional $1,000 for those aged 55 or older.
Balances grow tax-deferred, and withdrawals for qualified medical expenses are tax-free.
Unused funds roll over each year.
FSA:
Employer-sponsored accounts allow pretax contributions for medical expenses, subject to statutory limits.
Funds not used by year-end are forfeited, unless your plan offers a grace period or limited rollover options.
By leveraging these accounts, you can manage medical expenses without worrying about exceeding the AGI floor for deductions.
Smaller AMT Threat and Payroll Tax Considerations
The Alternative Minimum Tax (AMT) remains a concern for some taxpayers, particularly higher-income individuals, even though the Tax Cuts and Jobs Act (TCJA) reduced its impact. Here’s how to navigate AMT risks and payroll tax obligations effectively:
Alternative Minimum Tax (AMT)
Overview
The top AMT rate is 28%, lower than the top regular tax rate of 37%, but it often applies to a broader income base.
You must pay AMT if your AMT liability exceeds your regular tax liability.
TCJA Changes
Higher Exemptions: The TCJA significantly increased AMT exemptions through 2025, reducing the number of taxpayers subject to the AMT.
Fewer Deduction Differences: Aligning AMT and regular tax deductions has reduced AMT risks.
Triggers for AMT Liability
Certain items can still trigger AMT liability:
Long-term capital gains and qualified dividends (taxed at the same rate for both regular and AMT purposes).
Accelerated depreciation adjustments and gains or losses on asset sales.
Tax-exempt interest from private-activity municipal bonds.
Incentive stock option (ISO) exercises.
If AMT is triggered by deferral items (e.g., depreciation or ISO preference items), a credit may be available in later years when the timing differences reverse.
Strategies to Avoid or Reduce AMT
If AMT Applies This Year:
Accelerate income or short-term capital gains to benefit from the AMT’s lower top rate.
Defer expenses not deductible for AMT purposes to preserve them for next year, keeping SALT deduction limits in mind.
If AMT Applies Next Year:
Defer income to next year to avoid higher regular tax rates.
Consider selling private-activity bonds before year-end to minimize exposure.
Consultation
Work with a tax advisor to assess whether AMT might apply and to identify the most effective timing strategies.
Payroll Taxes
Employee Payroll Taxes
Social Security Tax: Applies to earned income up to the wage base limit (12.4%, split between employer and employee).
Medicare Tax: Applies to all earned income (2.9%, split between employer and employee).
Self-Employment Taxes
Self-employed individuals pay both the employer and employee portions of payroll taxes:
Social Security: 12.4%.
Medicare: 2.9%.
Deduction: The employer portion of self-employment taxes (6.2% Social Security and 1.45% Medicare) is deductible above the line.
Additional 0.9% Medicare Tax
Applies to FICA wages or self-employment income exceeding $200,000 ($250,000 for joint filers, $125,000 for separate filers).
Unlike other payroll taxes, this has no employer portion and is not deductible above the line.
Strategies to Manage the Additional Medicare Tax:
Income Timing: Adjust bonuses, stock option exercises, or equipment purchases to avoid triggering the tax.
Withholding Adjustments: If the tax is under-withheld, use a W-4 form to request additional withholding or make estimated tax payments to avoid penalties.
Special Considerations for Business Owners
S Corporations
Only salaries are subject to payroll taxes, including the 0.9% Medicare tax.
To minimize taxes, keep salaries reasonable but relatively low, increasing income taxed as distributions (not subject to payroll taxes or the 0.9% tax).
C Corporations
Salaries are subject to payroll taxes, but dividends are not deductible at the corporate level and may also trigger the 3.8% Net Investment Income Tax (NIIT).
Weigh the benefits of salary (deductible) vs. dividends (not deductible) for overall tax efficiency.
Partnerships and LLCs
Income from these entities is generally subject to self-employment taxes unless the partner/member qualifies for limited partner treatment.
Determine whether the additional 0.9% Medicare tax or 3.8% NIIT applies based on income source and structure.
Estimated Payments and Withholding
Avoiding Underpayment Penalties
To avoid penalties:
Pay at least 90% of the current yearâs tax liability or 110% of the previous yearâs liability (100% if prior-year AGI †$150,000).
Use the annualized income installment method if income fluctuates significantly throughout the year.
Year-End Adjustments
Increase Withholding: Additional withholding by December 31 is treated as paid evenly throughout the year, potentially reducing penalties for earlier underpayment.
IRS Tax Withholding Estimator: Use this tool to fine-tune withholding based on your income, deductions, and projected tax liability.