Do You Live in a High Cost City? Here are Easy Ways to Lower Your Taxes

When it comes to taxes, most Americans are lost. In a recent study by Reconcile Money, 59% of Americans admitted that they had no tax strategy when it came to investing—and another 10% said they didn’t know much about popular tax strategies.

The lack of strategy could be costing taxpayers, particularly Americans which are steeped in taxes. Cities like New York City, Detroit, the District of Columbia, St. Louis, Philadelphia, and Birmingham all levy local taxes—and there’s many more cities and counties which levy their own local taxes.

These taxes, when paired with state and federal income taxes, can have a huge impact on people’s earnings. The impact is even greater when you factor in the cost of property taxes, sales taxes, or other excises. However, there’s an easy way to put off your biggest tax bill to a later date: you can defer paying taxes by reducing your taxable income in the current year.

There are a lot of ways to do this, but the easiest and most popular way is simply to put your money in a pre-tax qualified account like an Individual Retirement Account (IRA), Health Savings Account (HSA), or 401(K).

How can I defer my tax bill with a 401(K) or IRA?

More than 50 million Americans live in a high tax, high cost urban area—and millions more live in a municipality or county which levies local taxes. As a result, many Americans might be paying more than a quarter of their income in federal, state, local, and FICA taxes.

Taxes serve an important role in keeping governments and cities running—they also act as a safety net for programs such as Social Security and unemployment insurance. And, as you hopefully have learned by now, they are an inevitability. One way or another, you will be paying taxes; but you might have some control over when and where you pay them.

The easiest way to pay less in taxes now is to make less money. But rather than actually make less money, you could make use of credits and deductions which reduce your taxable income on your tax return. This is where tax-advantaged accounts, particularly pre-tax qualified accounts such as IRAs or 401(K)s, come in.

Every dollar you contribute to a pre-tax qualified account is essentially ignored on your tax filing at the end of the year—and it will only be taxed when you go to withdraw it. In that sense, it means that contributing to a plan will defer their income tax bill until they go to withdraw the money.

In 2023, most Americans can max an IRA up to $6,500 (or $7,500 if over the age of 50.) If you’re covered by a workplace retirement plan like a 401(K), you can also go the extra mile by adding an extra $22,500 in contributions. However, that might be difficult, because there are income limits you should be aware of.

How do I get taxed on a pre-tax qualified account?

In a perfect world, your contributions to a pre-tax qualified account could continue to grow, only to be taxed when you withdraw money from these accounts in retirement. By then, you’d ideally have more control over where you live and could choose to relocate to a region which does not tax retirement income.

Unfortunately, the real world is more complicated than that. Politicos and financial-types believe that the U.S. will raise taxes in the future, which would mean that contributions to a pre-tax account like an IRA would be subject to higher taxes in retirement—and this is a leading reason why financial gurus have recommended the post-tax, Roth-flavored alternative.

However, if you live in a city like New York City—where most residents pay upwards of 30% in payroll taxes—virtually every other region in the country will have a lower tax liability. Furthermore, many states have moved to stop taxing retirement income.

The jury’s still out on whether or not tax rates will change dramatically, but there are still alternatives to taking a ‘wait and see’ position. If you relocate from a high cost, high tax region—and would like to take advantage of the lower liability to pay your qualified account bill—you could do that through a rollover of the account or Roth conversion ladder.

What other ways can I reduce my taxable income?

As public employees such as teachers and government officials might know well, your options for deferring your income don’t stop at 401(K)s and IRAs. There are many flavors of qualified accounts, including some which are available only to certain groups of people such as 403(b) or 457 plans.

There’s also a whole league of accounts which are popular among small businesses, freelancers, and solopreneurs. For people looking to sock away some dough from a side hustle or small business venture, SEP IRAs, SIMPLE IRAs, and Solo 401(K)s are a staple.

And even beyond that, there are still options such as a Health Savings Account (HSA) for medical expenses down the line, or a 529 account for education expenses.

Outside of investing accounts, other popular deductions such as the child tax credit (CTC) or home office deduction are available to Americans, which could help further reduce your tax liability—and keep more money in your pocket. 

Generally, using a mix of one or multiple accounts to maximize your deduction potential is a winning formula. That said, this is not always a tenable solution for people trying to cover their hefty rent and living costs. In any case, to make the best use of your time, money, and resources, consider consulting an accounting professional such as a CPA for advice.