By Justin May, Portfolio Manager

Everyone wants to lower their tax bill. But it’s not easy to do. One reason: our tax code is complicated, and it gets more complicated all the time.

You’ll never understand it all. But there are features you should know if you are serious about lowering your tax bill. This blog explains one rule which not many people understand: the IRS’s “order of operations” when calculating your tax bill. Below is a quick explanation of how income is taxed, then we’ll provide examples of how you can use this “order of operations” to your advantage.

In calculating your annual tax bill:

1. Start with ordinary income. This is primarily wages, but it also includes Social Security, IRA withdrawals, and interest from most bonds and bank accounts. The tax rate currently ranges from 10% - 37%. For high earners, this is the highest taxed income.
2. Subtract deductions. For most tax filers, this is the standard deduction (in 2026, $32,200 for married filers and half that for single filers).
3. Then add qualified investment income, like most dividends from stocks and long-term capital gains. This is taxed at lower rates, currently either 0%, 15% or 20%.

If you made it this far, here are ways you can use the “order of operations” to your advantage.

• If you’re looking for a good year to make a big charitable donation, focus on big ordinary income years – not big capital gain years. Imagine two years. In Year 1, you made $1 million in wage income and $0 in capital gains. In Year 2, you had no wage income but $10 billion in capital gains. You’ll pay more tax in Year 2, but the charitable deduction is more valuable in year 1, because it applies to ordinary income (at a 37% rate), not capital gains (at a 20% rate). It may feel like Year 2 is the better year to make a big contribution. It’s not.
• If you’re thinking about a Roth conversion, choose the years with low ordinary income. From the example above, Year 2 would be best. In other words, even if you have a massive capital gain in a particular year, it could still be a good year to make a Roth conversion if your ordinary income is low.
• Don’t own municipal bonds unless you have high ordinary income. Municipal bonds are federal tax-free (and free of state income tax for that state’s residents), but they pay less interest because of this. Generally, they make sense only for people with an ordinary income tax rate of about 30%. So, if you’re someone with a massive capital gain income but no ordinary income, municipal bonds probably don’t make sense.

And now, the disclaimer you’ve been waiting for. Everyone’s tax situation is unique, and this blog ignores many wrinkles in the tax code which may impact the right strategy for you. Speak with a professional before you implement a strategy. When you do, an understanding of the “order of operations” will help you figure out what works, and what doesn’t, to lower your tax bill.