What Counts as Taxable Income and Ways to Help Reduce It

By Stephen W. Bedikian, Associate Wealth Advisor

As the year comes to an end, you might be thinking about fun things like the upcoming holidays—and some not-so-fun things like year-end tax planning. More specifically with the latter: Is there anything I can do now to lower my tax bill?

To answer that question, here’s where to start. You first need to total up your income year-to-date and then project the full year amount. Remember that not all income is taxed at the same rate.

What counts as taxable income?

1. Ordinary Income.

This is typically your salary reported on a W2 form or a 1099 for contract work. The marginal tax rate increases as income rises, with rates starting at 10% and rising all the way up to 37%. Think of each tax bracket as a bucket that you fill up.

Single filers pay a 10% rate on their first $11,925 bucket of income. In the second bucket, between $11,925 – $48,475, single filers pay 12%—and so forth up to your total earned income.

High income earners will typically pay a higher ‘effective’ or average rate because they have more income that is taxed at progressively higher rates.

1. Interest Income

Interest you earn on a money market fund, high-yield savings account or CD is taxed at ordinary income rates. If you earn 5% on a high-yield savings account, that’s the pre-tax yield. If you’re in the 24% tax bracket, the after-tax yield amounts to 3.8%.

Interest paid on federal government securities is taxable at the federal level but not at the state or local level. Municipal bond interest is typically triple-tax free—but the yields offered usually reflect that advantage.

1. Dividends and Capital Gains.

If the investment is short-term—with the IRS defining short-term as an investment held for exactly one year or less—the capital gains are taxed as ordinary income. However, if you hold the investment for more than one year, then the capital gain you realize when you sell it is taxed at a lower rate than ordinary income.

The rate is either zero if your income is less than $47,025 for a single filer or $94,050 for joint filers; 15% for single filers with income between $47,025–$518,900 or between $94,050–$583,750 for joint filers; or 20% if your income is above those amounts. You may also have to pay the 3.8%

Net Investment Income Tax (NIIT) on the lesser of an individual’s net investment income or the amount by which their modified adjusted gross income (MAGI) exceeds $200,000 for single filers or $250,000 for joint filers.

1. Qualified Dividends.

This is a sub-category based on certain criteria. Qualified dividends are taxed at the (lower) long-term capital gains rate if they meet these criteria. Common stock holdings must be held more than 60 days during the 121-day window starting 60 days before the ex-dividend date.

For preferred stock, the holding period is more than 90 days within the 181-day window that starts 90 days before the ex-dividend date. Additionally, the investor must maintain an unhedged position during the holding period.

If the stock, mutual fund, or ETF you hold meets these criteria, dividends are taxed at the long-term capital gains rate, which can be highly advantageous for long-term buy-and-hold investors.

Dividends paid by REITs and MLPs are not qualified. They are always taxed as ordinary income.

1. Collectibles.

This category includes art, gems, stamps, and coins—even wine and precious metals like gold and silver. These assets produce no yield and thus no annual taxes, so Congress has chosen to set the tax rate at a maximum of 28% on collectible capital gains to provide a disincentive to holding them.

1. Rental Income.

Is rental income taxable? Yes. You will pay ordinary income tax rates on your net rental income. Typically, though, the net income from a rental property is lower than its cash flow because depreciation is a non-cash expense that reduces the taxable net income. And don’t forget all those rental improvements (see below).

1. Social Security Benefits.

Yep, Social Security income is also taxable at ordinary rates! The taxable amount is based on your Combined Income, which is your adjusted gross income (AGI) plus any nontaxable interest you received plus half of your Social Security Benefits.

The first $25,000 is tax free for single filers or $32,000 for joint filers. For single filers with combined income between $25,000–34,000, 50% is taxable; and 85% of benefits are taxable for income above $34,000. For joint filers, it’s 50% taxable for combined income between $32,000–$44,000 and 85% taxable for income above $44,000.

Congratulations! You’ve basically filled out the first 8 lines of your IRS Form 1040.

Ways to help reduce your taxable income

Now that you’ve totaled all your expected income for the year, what can you do to help reduce the taxes you’re going to owe? Basically, you’re trying to lower your income amounts; increase your deductions; or qualify for a credit.

Here are some options to help reduce your taxable income:

• Retirement Contributions. Do Traditional 401k contributions reduce taxable income? You bet. If your employer has a 401k or similar retirement plan, max it out. You can contribute up to $23,500; this reduces your taxable income dollar-for-dollar. If you’re over 50, you can contribute up to $31,000. If you are in the 24% federal tax bracket, you just saved more than $7,000 in taxes this year.

To be clear: Taxes are deferred so at some point, potentially decades in the future, you will have to pay income tax when you withdraw those funds from your account.

• HSA Contributions. These contributions are often considered tax-advantaged. You pay no taxes on contributions, or gains while the funds are in your HSA, and if you use the money on qualified expenses, you also pay no taxes on funds you withdraw. If possible, it’s best to invest and leave funds in your HSA for the long term to help take advantage of tax-free compounding. Use cash for your medical expenses if possible.

Single filers can contribute $4,300 annually (+$1,000 if you’re over 50) and families can contribute $8,550 in 2025. Take a look at IRS Schedule 1, line 13 and you can see right where that deduction will appear.

• IRA Contributions. If your employer doesn’t offer a retirement plan, you can make a tax-deductible IRA contribution of $7,000 if your modified adjusted gross income is less than $79,000—or $126,000 for married couples. There is a phaseout above those levels.
• 529 Plan Contributions. Contributions to a 529 plan for your children’s education may be deductible in more than 30 states but not on your federal tax return.
• Tax Loss Harvesting. If any of your investments like stocks or ETFs are in the red, you can sell and buy back after 31 days to avoid the wash sale rule if you still like the investment. This can help reduce your capital gains. You can also utilize the loss to reduce your ordinary income by up to $3,000 annually if you don’t have capital gains to match against your losses.

Conversely, it may be prudent to hold off selling a profitable investment until next year if possible if you’re concerned about your tax bill this year and don’t have losses to help offset your gains.

• Itemized Deductions. If you itemize your deductions, you can prepay your property taxes to increase your state and local tax deduction (SALT) for the current tax year. You can also make charitable contributions to increase your itemized deductions. Those can be given to a specific charity or put into a donor advised fund (DAF) that you can use for future donations.
• Qualified Charitable Distributions. If you are 70½ and currently take taxable IRA distributions, you can direct a distribution directly to a charity to reduce the taxable amount of your distributions. The maximum annual QCD amount is $108,000 for individuals or $216,000 for joint filers. (Unfortunately, 401k accounts are not eligible for QCDs.)
• Rental Improvements. If you own rental property, you can spend some money on improvements to potentially increase future rental income. In the meantime, those expenses will reduce your net income for tax purposes or increase the size of the reported loss, which can reduce your total taxable income.

Starting early helps you plan tax reductions and avoid surprises

In general, it’s best to start your tax planning earlier in the year. This can give you time to set the proper amounts for retirement plan, HSA, and charitable contributions; calculate your required minimum distributions (RMDs) and qualified charitable distributions (QCDs) for folks who take IRA distributions; and execute other strategies that can allow you to pay less in taxes come next April.

Here at Halbert Hargrove, we like to review client tax returns shortly after the April 15th filing deadline. That’s so it’s fresh in their mind and may be motivated to discuss options to help reduce next year’s tax bill. Please be in touch with us with any questions you may have—the sooner before year-end, the better.

Note: all amounts cited are for 2025 and may be subject to adjustments in future tax years.

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