Taxes are one of the biggest bills you will pay in your lifetime. Ensuring that you, your family, and your business have proven tax strategies to save on taxes is key. Congress is constantly changing the tax laws, so it is important that you stay up to date on what is relevant to your situation. Rely on your CPA and your financial planner to help you improve your tax planning. We should always pay the amount of taxes that we are required to pay, but it is vital to know how our taxes work, and then what you can do to reduce it.

How Taxes Work

The United States has a progressive income tax system. That means you pay more taxes as you make more income. That also means the “last dollar” you earn will be at a higher tax rate than your first. For an oversimplified example, if John and Jane are married and take home $150,000 in income this year, they would likely be in the 22% federal income tax bracket. The first $29,200 of that $150,000 would be tax free (taking the standard deduction), then $23,200 is taxed at 10%, $71,100 taxed at 12% and finally the last $26,500 taxed at 22%. That is why your tax bracket is called your marginal income tax rate, because it is the rate that the last dollar of income you receive is taxed at. Most people roughly understand how these tax brackets work, but unfortunately it is almost never that simple.

The government also expects every person to pay 15.3% into Social Security and Medicare, up to $168,600 in income for 2024 (Above that it drops to 2.9%)¹. Fortunately for all W-2 employees, they only have to pay half of the 15.3%, or 7.65%, and their employers must pay the other half. If you are self-employed, then you are responsible for all 15.3% (though you do get a deduction for the employer side). This is what the industry talks about when we say you owe Self-Employment Tax.

There are many other taxes, deductions, credits, etc. that I didn’t mention that could change someone’s tax situation. Because of this, you should also know your effective tax rate, or what percentage of your income goes to taxes. In our example above, let’s say John and Jane are self-employed and the $150,000 in income produced $40,000 in total taxes. By dividing $40,000 by $150,000, the effective tax rate would be 26.7%. Even though their marginal income tax rate is 22%, 26.7% of their total income is going to taxes. There will always be exceptions and nuances to pay attention to, but understanding both your marginal and effective tax rates are a great first step in understanding how taxes affect you.

Be Proactive

The tax system is a “pay as you go” system, which means your taxes are roughly due when you receive the income. Many W-2 employees don’t fully recognize this since their taxes are taken out of their paycheck automatically each time. Once you become a small business owner, you usually don’t have that luxury. This is why having an intentional tax strategy is vital. The more intentional and proactive you are, the greater chance you have to reduce your lifetime tax bill.

From 2000 to 2022, there have been on average 399 tax law changes, each year².  Congress will never stop changing laws, so you should know about any change that could affect you. If the only time you talk to your tax preparer is in the second week of April, you are likely not doing enough tax planning. You need to communicate with your entire financial team periodically throughout the year. Working with a CPA can keep you compliant with all these new rules and help you file and pay your taxes. Hiring a financial planner can help you integrate your CPA’s recommendations into your cash flow plan and overall financial plan. The further into the future you can plan with your financial team, the higher likelihood you can save on taxes. 

Maximizing all of your deductions and getting the lowest tax bill possible this year is not always the best strategy long-term. As a financial planner, I constantly try to help clients understand their lifetime tax bill, not just the current bill. As it stands today, the federal tax brackets are set to increase in 2026, as a result of the sunsetting of the Tax Cuts and Jobs Act³. In 2026, the 24% federal tax bracket is expected to rise to 28%. Knowing this, it could be wise to purposely hold off on certain deductions until 2026 if your tax rate would be higher. Each person’s situation is vastly different, but it is easy to see where you could save on taxes when you know what is coming.

How Business Owners Can Save On Taxes

One of the best places to start to save on taxes as a business owner is by selecting the right business entity structure. You should know why your sole proprietorship, partnership, corporation, etc. is the best entity for your business. Many times, people can file an election or change the structure entirely to optimize their tax situation. LLCs electing to be taxed as a S-Corp is a very popular strategy to reduce your self-employment tax (SE tax). It is worth noting though, that any tax or legal change in your business will bring new responsibilities for you. S-Corps could save thousands of dollars on SE tax, but there will be additional costs and rules to follow to do it correctly.

After optimizing your entity structure, Schedule C deductions are a business owner’s best friend. Sometimes though, the best deductions are not fully utilized. For example, maximizing the Qualified Business Income Deduction is a big one. The IRS will let you deduct up to 20% of qualified business income up to a certain income limit. You’d be surprised how many people do not get the most out of this. The Home Office Deduction is another one. It’s not a stretch to say nearly every business owner has worked at home at some point. Work with your CPA to see if these work with your situation, but maximizing easy deductions can help lower your taxes.

One of the best tax planning tools is contributing to tax-advantaged accounts. Opening a Solo 401k or SEP IRA could allow you to contribute tens of thousands of dollars towards retirement and lower your taxable income at the same time. With the right situation, you could save $50,000+ into a Solo 401k and defer $15,000+ of taxes this year (assuming a 30% tax rate). This idea also applies to HSA accounts, which most people have roughly heard about. These tax-advantaged accounts were designed to help you save and pay for all your healthcare expenses tax-free, if done right. Given the fact that health care can be one of the biggest expenses in life, this is a popular account to have.

Focus on What is Important to You.

Reducing taxes will always be a focus for people, but don’t let it control your entire financial plan. You should focus on your goals and plans for your future, and then work to fit tax planning around that. Understanding how taxes actually work is the first step. Once you understand what levers you can pull, it allows you to be more proactive. When you and your financial team are all on the same page, looking for tax opportunities, you can find ways to save on your lifetime tax bill.

Sources: ¹IRS, ²National Taxpayers Union Foundation, ³Congressional Research Service