5 Ways to Reduce Your Taxes After a Windfall Gain

Getting a windfall is a great way to stabilize your finances and lay a strong foundation for savings and retirement whether you win the lottery, cash in at the casino, receive an inheritance from your great-aunt, or just found some money you never realized you socked away. But depending on the source, the United States government may want its share. This means you may have to report your new fortune on your annual tax return. Below, you'll find some tips to help you lower your tax bill while you pay your fair share.

1. Understand Tax Implications

Before you start to worry, research the tax rules for your specific income source. If the income comes from something like a lottery or employer, you'll need to pay full taxes at your tax bracket on the income. Other sources have different rules. For instance:

• If your income comes from investment gains, you will need to pay capital gains tax, which changed with the Tax Cuts and Jobs Act (TCJA), signed into law on Dec. 22, 2017.
• If your 2022 regular income is less than or equal to $40,400 ($44,625 in 2023) for single or $80,800 ($89,250 in 2023) for married filing jointly you do not need to pay any capital gains tax. If your income is greater than $40,400 ($44,625 in 2023) for single or $80,800 ($89,250) for married filing jointly, but less than or equal to $445,850 ($492,300 in 2023) for single or $501,600 ($553,850) if you're married filing jointly, you pay 15%.
• If your income exceeds the 15% threshold, your capital gains tax rate is 20%. There are also exceptions where certain capital gains might be taxed at higher than 20%.

2. Fund an IRA

The first place to look to lower your taxes is in your retirement accounts. Contributions to a traditional individual retirement account (IRA) or a 401(k) plan are tax-deductible. That means you don't pay any taxes on the money you contribute to the IRA.

For 2022, the total contributions to all of your traditional and Roth IRAs cannot be more than $6,000 ($7,000 if you're age 50 or older), or your taxable compensation for the year, if your compensation was less than this dollar limit. For 2023, the maximum contribution limit rises to $6,500 ($7,500 if you're age 50 or older).

Income limits apply to IRA contributions, and you will pay income taxes on withdrawals in the future. However, those withdrawals will be made when you'll likely have a lower income, so your total taxes paid will be lower.

3. Fund an HSA

If you have a high-deductible health plan (HDHP), you'll probably qualify for a health savings account (HSA). With an HSA, the funds may be used only for qualified medical expenses such as doctor appointments, hospital visits, prescription medications, and doctor-ordered lab tests.

With an HSA, your contributions are tax-deductible, and you pay no taxes on withdrawals. This means that you keep the funds in your HSA for life, so savvy savers use the account as a supplemental retirement account.

The IRS limits for 2022 for HSAs are $3,650 for individual coverage and $7,300 for family coverage. For 2023, the limits rise to $3,850 and $7,750 respectively. The catch-up contribution limit for those older than age 55 will remain at $1,000.

4. Sell Sluggish Stocks

If you have underperforming stocks in your portfolio, you can sell stocks at a loss to lower your capital gains for the year. Capital losses can offset capital gains but cannot be used to lower your taxes beyond that amount. Any additional capital loss is carried over to the next year.

5. Research Additional Deductions and Credits

There are dozens of tax deductions and tax credits available that many Americans don't take. While you already likely know about tax credits for parents, additional education-related deductions and credits are available. Those are available for both children and classes at an accredited college or university that you are taking yourself.

If you incurred steep health care expenses in a single calendar year, you might be able to write those costs off as well. To take advantage of health care tax deductions, your spending on healthcare must meet certain minimums and criteria that vary based on your income.

The Bottom Line

We cannot escape paying taxes, but good planning and understanding can help you keep your tax bill as low as possible. Do your research ahead of time so you won't need to scramble at the end of the year or in the weeks leading up to tax day.