If your wages have risen this year, that's good news. But along with the additional cash, it's possible you may be in for an unpleasant tax surprise too.
Although wage increases may have helped your income keep pace with rising costs for everything from food to housing and auto repairs, a bigger paycheck may also bump you into a higher marginal tax bracket, in a phenomenon called tax-bracket creep.
Tax-bracket creep happens during periods of high inflation when wages rise, pushing people into higher tax brackets. It can result in a double hit to your wallet as the rising cost of many common consumer items crimps budgets, while your extra pay could potentially increase your tax bill.
While the federal government adjusts marginal tax brackets for inflation each year, it does not make adjustments to numerous credits, deductions, exemptions, and surcharges, which can mean your effective tax rate could go up, whether you take the standard deduction or itemize.
For example, the net investment income tax (NIIT) on capital gains, dividends, and interest income has not been adjusted since it was enacted in 2013. It's an added 3.8% surtax on everything from home sales to interest paid on CDs and taxable bonds if those things push your income past $200,000 for a single person and $250,000 for married couples. The NIIT is particularly worth paying attention to as house prices continue to rise and as interest rates have pushed yields up for both bonds and CDs.
Here are 8 steps to consider now to help you reduce your tax bill and reduce tax-bracket creep.
1. Maximize retirement contributions
Fortunately, you can reduce your taxable income dollar-for-dollar with yearly contributions to your 401(k), IRA, and other retirement accounts.
People who have access to a workplace retirement plan can contribute up to the maximum of $23,000 for 2024 (up from $22,500 in 2023). People age 50 and older can make additional catch-up contributions of $7,500.
Contribution limits to IRA plans have also increased to $7,000 for 2024, compared to $6,500 for 2023. (Catch-up contributions remain at $1,000.)
The tables below can help you figure out how much of your traditional IRA contribution you may be able to deduct based on your income, tax-filing status, and your and your spouse's access to a workplace retirement plan.
Traditional IRA deduction limits
| 2024 IRA deduction limit — You are covered by a retirement plan at work | ||
|---|---|---|
| Filing status | Modified adjusted gross income (MAGI) | Deduction limit |
| Single individuals | ≤ $77,000 | Full deduction up to the amount of your contribution limit |
| > $77,000 but < $87,000 | Partial deduction | |
| ≥ $87,000 | No deduction | |
| Married (filing joint returns) | ≤ $123,000 | Full deduction up to the amount of your contribution limit |
| > $123,000 but < $143,000 | Partial deduction | |
| ≥ $143,000 | No deduction | |
| Married (filing separately)1 | < $10,000 | Partial deduction |
| ≥ $10,000 | No deduction | |
Source: "401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000," Internal Revenue Service, November 1, 2023.
| 2024 IRA deduction limits — You are NOT covered by a retirement plan at work | ||
|---|---|---|
| Filing status | Modified adjusted gross income (MAGI) | Deduction limit |
| Single, head of household, or qualifying widow(er) | Any amount | A full deduction up to the amount of your contribution limit |
| Married filing jointly with a spouse who is not covered by a plan at work | Any amount | A full deduction up to the amount of your contribution limit |
| Married filing jointly with a spouse who is covered by a plan at work | $230,000 or less | Full deduction up to the amount of your contribution limit |
| > $230,000 but < $240,000 | A partial deduction | |
| ≥ $240,000 or more | No deduction | |
| Married filing separately with a spouse who is covered by a plan at work | < $10,000 | Partial deduction |
| ≥ $10,000 | No deduction | |
Source: "401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000," Internal Revenue Service, November 1, 2023.
2. Remember your health savings account (HSA)
If you're eligible to contribute to an HSA because you have a high-deductible health plan, contribution limits are now $4,150 for individuals and $8,300 for families for 2024, with an additional $1,000 in catch-up contributions for those over 55. If both spouses are covered by a family high-deductible health plan and share an HSA, they are eligible for one catch-up contribution of $1,000 if one of them is 55 or older and not enrolled in Medicare. If both are 55 or older and both are not enrolled in Medicare, however, and they each want to make a catch-up contribution, they must do so in separate HSAs, resulting in a $10,300 limit. Note: The aggregate amount spouses may contribute to separate accounts is $8,300.
3. Defer payouts and payments
If you sold a house, collected severance from a job after a layoff, or sold anything of value where you expect a taxable gain, it's worth considering whether you can collect the money the following year if the additional income pushes you into a higher tax bracket, or you expect to be in a lower tax bracket the following year. Similarly, if you plan to sell stock that has increased in value, you could think about splitting the sale over 2 years if the full amount will push you into another tax bracket, or subject you to the NIIT surtax. Relatedly, if you've done contract work in addition to your regular job to make ends meet, you might consider delaying payment until the following tax year if the extra income will push you into a higher tax bracket.
Important to know: Any capital improvements to your home can increase the property’s cost basis and thus reduce capital gains, so it’s important to make sure you have good records of any improvements you've made. You also can exclude $250,000 ($500,000 for couples who are married filing jointly) of gains from income if you owned and used your home as your main home for a period aggregating at least 2 years out of the 5 years prior to its date of sale. If you sold another home and used the exemption in the prior 2 years, then you cannot claim it again. There are certain exceptions to these eligibility tests.
4. Make the best use of a Roth conversion
While Roth conversions from a traditional IRA are fully taxable, you aren't required to take money out of a Roth once the funds are in the account, as you would need to do with a traditional IRA, where required minimum distributions (RMDs) must begin at age 73. After that, payouts aren't subject to taxes when you do withdraw funds, assuming you've met all conditions for the account, including the 5-year aging rule and are 59½ years old or older. Additionally, a conversion may reduce the value of the traditional IRA from which the funds were transferred, which could in turn lower RMDs from the traditional IRA.
5. Tax-loss harvesting
You might also want to consider year-round tax-loss harvesting where you use realized losses to offset gains elsewhere, plus up to $3,000 of ordinary income depending on filing status. If you've got investments that are below their cost basis, and there's another investment that's similar (but not a substantially identical security), you could use it to replace the sold asset without a material impact to your investment plan. Consult your tax advisor about your situation and beware of the wash-sale rule.
6. Make full use of asset location
You're likely to have different types of accounts that can be aligned with specific financial goals. Some accounts, like brokerage accounts, are subject to income or capital gains taxes every year on any income earned or capital gains realized, while others (retirement accounts) can have tax advantages, such as tax-deferral or being tax-exempt (Roth accounts).1 At the same time, some types of investments—think bonds, bond funds, and high-turnover, actively managed stock mutual funds—can have bigger tax consequences. Consider putting the higher-tax investments in accounts with more favorable tax treatment, such as tax-deferral or tax-exemption.
Find out more about tax-smart asset location in Viewpoints: Are you invested in the right accounts?
7. Qualified charitable distributions (QCDs)
For individuals in retirement who have to take required minimum distributions, donating to charity can help reduce tax-bracket creep. You can make a QCD from an IRA of up to $105,000 per individual (or $210,000 total if you're married and filing jointly), as long as the charity receives your donation by December 31. The money you donate is not deductible, but it's not subject to federal taxes, qualifies as your RMD for the year, and you can use one even if you don't itemize. QCDs are also allowable starting at age 70½, so you don't have to wait until RMDs begin to take advantage of one.
Important to know : Payment must be made directly to a charity and not all charities qualify.
8. Deductions for charitable contributions
If you have extra money to give this year, you might consider bunching, which involves concentrating charitable deductions in a single year, and skipping the following year, or even several years. The following year, you likely wouldn't claim charitable deductions, but you'd still qualify for the standard deduction. And if you put your contributions into a donor-advised fund, you can take the charitable deduction in 2024, but spread your giving out over many years. If you want to itemize, this strategy can help. Itemizers can also donate appreciated assets held longer than one year to a qualified public charity and deduct the fair market value of the asset without paying capital gains tax.
Similarly, itemizers can deduct cash contributions as well as property—think the bookshelf you donate to your local school. Deducting charitable contributions may be subject to adjusted gross income (AGI) limits depending on the receiving charity and what you donated.2
The good news is inflation is showing signs of easing this year, and federal tax brackets (and the standard deduction) are likely to be adjusted upward again this fall to compensate for the higher cost of living. Nevertheless, it's still a smart idea to keep tax-reduction strategies in your back pocket to meet the potential burden of tax-bracket creep. As always, consult with your tax advisor or a financial professional to create a plan that works for you.