Chances are, maximizing your tax savings is top of mind this time of year—especially if you have multiple income streams. When dealing with income from various sources—a job, a business, investments, and more—tax time can get complicated. Fortunately, there are plenty of ways to maximize your tax savings. So read on to discover five tried-and-true best practices that every multi-income earner should know to minimize their tax burden.

Understand the Different Tax Rates That Apply to Different Sources of Income

Different tax rates can apply to different sources of income. For example, long-term capital gains—profits from the sale of assets such as stocks, bonds, mutual funds and real estate you’ve owned for more than a year—are generally taxed at a lower rate than ordinary income—wages from a job or profits from a business.

The federal income tax rate on long-term capital gains depends on your total taxable income, but it can be as low as 0% and as high as 28%. Meanwhile, tax rates on ordinary income and short-term capital gains range from 10% to 37%.

When you understand the tax rates that apply to different sources of income, you can plan accordingly and maximize your tax savings. For example, you can hold onto investments for more than a year to take advantage of lower long-term capital gains tax rates or harvest losses from poor investments to offset capital gains.

Utilize Tax-Advantaged Accounts

A tax-advantaged retirement account can be a great way to reduce your taxable income. Here’s a quick overview of some of the most widely used tax-advantaged retirement accounts:

• A Traditional IRA allows you to save for retirement on a tax-deferred basis. You may be able to deduct contributions depending on your income and whether you have access to an employer-sponsored retirement plan. In addition, funds in the account can grow tax-free until you start taking withdrawals in retirement.
• Contributions to a Roth IRA aren’t tax deductible, but you can withdraw your contributions and earnings in retirement without paying taxes on the withdrawals. There are income limits for contributing to a Roth account, but if you qualify, they’re an excellent way to create tax-free income in retirement.
• A 401(k) plan allows employees to contribute pre-tax dollars to a retirement savings account. Contributions to a traditional 401(k) are tax-deductible in the year you make them, and investments within the account can grow tax-free until withdrawn.
• A SEP-IRA is a tax-advantaged retirement account that allows self-employed people and small business owners to contribute to their own or their employees’ retirement accounts. SEP-IRA contributions are tax deductible.

You can also leverage tax-advantaged accounts to save for healthcare costs. For example, if you have a high deductible health plan (HDHP), you can contribute to a Health Savings Account (HSA). Contributions to the account are tax-deductible. You can withdraw the money tax-free if you use it to pay for qualified medical expenses, such as doctor visits, prescription drugs and vision care. Any unused funds roll over from year to year.

Flexible Spending Accounts (FSAs) are tax-advantaged accounts available through employers. Like an HSA, they allow you to set aside pre-tax money for medical expenses. Contributions to a flexible spending account are tax-deductible, and you can use the funds to pay for qualified medical expenses. However, unlike an HSA, FSAs have “use it or lose it” rules, meaning unused funds in the account don’t roll over from one year to the next.

Taking advantage of various tax-advantaged accounts can help you save money and reduce your total tax liability.

Choose the Right Business Structure

Choosing the right business structure can be a great way to maximize your tax savings. Depending on the type of business you are running, different types of structures may be beneficial for tax purposes. For example, if you run a sole proprietorship, partnership, or limited liability company (LLC), you won’t be liable for corporate taxes, but your profits are taxed as personal income. On the other hand, if you elect to have your LLC taxed as an S corporation, you may be able to reduce your self-employment taxes.

The right business structure depends on several factors, including the type of business you’re in and your overall tax situation. For that reason, it’s a good idea to discuss the decision with your tax professional. We can help you run the numbers to help you make the best decision for your circumstances.

Understand Passive vs. Active Income

The difference between active and passive income is a critical distinction that can have a big impact on your tax liability. Active income comes from employment, such as wages and salaries or profits from a business you actively participate in. Passive income comes from earnings from rental properties, royalties, and companies you don’t actively participate in.

Often, clients assume that losses from a rental property or passive business will offset other types of income, but that usually isn’t the case because of passive activity loss rules. Passive activity loss rules limit your ability to shelter salaries, wages, and other income with deductions from activities in which you don’t “materially participate.”

For example, say you’re a silent investor in a startup generating losses while the company gets off the ground. You can use those losses to offset income from other passive activities, such as a rental property, but not income from your consulting business that you’re actively involved in.

If you’re considering investing in a new venture or property, it’s a good idea to discuss it with your accountant to ensure you know how it will impact your federal income taxes.

Take Advantage of All Available Tax Deductions and Credits

Tax credits and deductions can be a great tool to reduce taxable income and maximize your tax savings.

Common federal tax deductions for individuals include the standard deduction, charitable donations, medical expenses, state and local taxes, and mortgage interest. If you own a business, you can deduct ordinary and necessary business expenses. These vary depending on your industry, but some common examples include costs of goods sold, salaries and wages, advertising expenses, rent, utilities, supplies, and the home office deduction.

While a tax deduction lowers your taxable income, tax credits are a dollar-for-dollar reduction in the amount of tax you owe. Some common examples of tax credits for business owners include the Research & Development Credit, the Work Opportunity Tax Credit, and the new Clean Vehicle Tax Credit.

To claim these deductions and credits, be sure to track all your deductible expenses throughout the year. Keeping accurate records of expenses can help you maximize tax savings when you file your return.

Multiple income streams can be a great way to build wealth and financial security. But it’s essential to do some tax planning to ensure you take full advantage of every potential tax deduction and other saving opportunities. If you need help lowering your taxable income, contact NewWay Accounting today. We’d love to work with you to create an optimal tax plan that helps you minimize your tax burden and save money.