Tax Rate Arbitrage: Moving a Dollar to a Lower Tax Rate

Here's a simple idea behind a lot of good tax planning: the same dollar can be taxed very differently depending on where it lands. A smart strategy often isn't about finding a new deduction — it's about legally moving income to the spot where it's taxed less.

A few places this shows up

Ordinary income versus capital gains is the biggest one. Ordinary income can be taxed as high as 37%, while long-term capital gains top out at 20%. Selling an asset the right way, instead of the wrong way, can mean a very different tax bill on the exact same gain.

Retirement accounts are another. Money in a 401(k), SEP IRA, or HSA is taxed later, or sometimes not at all, instead of being taxed this year. Contributing $72,000 to a solo 401(k) in a 35% tax bracket moves about $25,000 of tax out of this year.

Your own income can vary a lot year to year too. A slower year is often a good time to convert retirement funds to a Roth, or to take a deduction you were planning to use anyway.

A couple of things to know

Tax rates and rules can change, so a strategy that works today may look different in a few years. And a few moves, like Roth conversions, can't be undone — so it's worth thinking it through before you act, not after.

The takeaway

Before a sale, a big deduction, or a retirement contribution, it's worth asking what rate that money is taxed at right now, and whether there's a better spot for it.

If you have a sale or a big financial decision coming up, we can help you look at the timing. Reach out to Bottala Tax & Advisory at info@bottalacpa.com.