How to Decrease My Taxable Income

There's no secret to reducing your taxable income. The most important factor is lowering your adjusted gross income (AGI). This can be done through many methods, as long as you follow IRS and state laws and requirements. Obviously you don't want to simply reduce your income -- which is probably the simplest way to reduce your taxable income. The key is to use all the tools at your disposal to reduce your taxable income. You still can enjoy the same income level while at the same time reducing your tax burden.


Step 1

Take advantage of all deductions, allowances, tax credits and exemptions afforded you on your tax return. On IRS Form 1040, for example, you'll want to make sure you claim all your dependents (usually your children) in the "Exemptions" section. Also use lines 23 through 37 in the "Adjusted Gross Income" section to reduce your AGI as much as possible. Business expenses, HSAs (health savings accounts), moving expenses, interest payments and early-withdrawal penalties all contribute to lowering your AGI. Next, include all applicable entries in the "Tax and Credits" section. Make sure to compare your deductions with a possible itemized-deductions return and use the higher of the two figures.


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Step 2

Contribute maximum amounts to any 401(k) plans you have. Some employers have their own limits that may be less than the IRS-established limit ($16,500 for those under 50, $22,000 for people 50 and older in 2011). Don't worry that your employer may not match your contribution over a certain amount. Your contribution still reduces your AGI.

Step 3

Open, or contribute to, an IRA. You can simultaneously contribute to both a 401(k) and an individual retirement account. In most instances, IRA limits were $5,000 for 2010 ($6,000 if you're over 50). There are some strategies and pre-tax considerations involved when contributing to dual retirement accounts, but the advantages can be enormous. And don't forget that self-employed people can contribute even more to their retirement accounts. For instance, a business couple may be able to contribute as much as $109,000 ($54,500 each) a year to a Solo 401 (k) account.


Step 4

Talk to your employer about changing your pay structure, especially if you are due a raise (which is the ideal time address your payment structure). Getting creative can benefit both you and your employer. For example, in lieu of a raise, you might suggest that your employer pay your health insurance premiums. Your income remains the same, saving you taxable income, and you gain the added benefit of having an additional few thousand dollars each year (the cost of your premiums) in your pocket. Your boss enjoys both the health-care coverage write-off and not having to pay additional payroll taxes. You can take the same approach with other "benefits" such as life insurance, education costs, transportation and parking expenses, and flexible spending account (cafeteria-style) benefits.


Step 5

Review your investment portfolio to see if you can make adjustments to reduce your AGI. Non-taxable and tax-free bonds, such as municipal bonds, can decrease both federal and state tax burdens. You also can consider moving things around, like making sure that your interest-producing investments are in retirement and other tax-deferred accounts, and that your capital gains and dividend-producing investments are in areas other than retirement accounts. Interest income is taxed at a higher rate than capital gains and dividend income, but is not considered taxable income as long as it's in a retirement account.


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