A great article I thought I would share with you.
Tax Planning Basics 3 Ways to Reduce Your Taxes The goal of tax planning is to
arrange your financial affairs so as to minimize your taxes. There are three
basic ways to reduce your taxes, and each basic method might have several
variations. You can reduce your income, increase your deductions, and take
advantage of tax credits. Reducing
Income Adjusted Gross Income (AGI) is a key
element in determining your taxes. Lots of other things depend on your AGI (or
modifications to your AGI)-- such as your tax rate and various tax credits. AGI
even impacts your financial life outside of taxes: banks, mortgage lenders, and
college financial aid programs all routinely ask for your adjusted gross
income. This is a key measure of your finances. Because your adjusted gross income
is so important, you may want to begin your tax planning here. What goes into
your adjusted gross income? AGI is your income from all sources minus any
adjustments to your income. The higher your total income, the higher your
adjusted gross income. As you can guess, the more money you make, the more
taxes you will pay. Conversely, the less money you make, the less taxes you
will pay. The number one way to reduce taxes is to reduce your income. And the
best way to reduce your income is to contribute money to a 401(k) or similar
retirement plan at work. Your contribution reduces your wages, and lowers your
tax bill. You can also reduce your Adjusted
Gross Income through various adjustments to income. Adjustments are deductions,
but you don't have to itemize them on the Schedule A. Instead, you take them on
page 1 of your 1040 and they reduce your Adjusted Gross Income. Adjustments
include contributions to a traditional IRA, student loan interest paid, alimony
paid, and classroom related expenses. A full list of adjustments are found on
Form 1040, page 1, lines 23 through 34. The best way to boost your adjustments
is to contribute to a traditional IRA. As you can see, two of the best ways
to reduce your taxes is to save for retirement, either through a 401(k) at work
or through a traditional IRA plan. Contributions to these retirement plans will
lower your taxable income, and lower your taxes. Increase
Your Tax Deductions Taxable income is another key
element in your overall tax situation. Taxable income is what's left over after
you have reduced your AGI by your deductions and exemptions. Almost everyone
can take a standard deduction, and some people are able to itemize their
deductions. Itemized deductions include expenses
for health care, state and local taxes, personal property taxes (such as car
registration fees), mortgage interest, gifts to charity, job-related expenses,
tax preparation fees, and investment-related expenses. One key tax planning
strategy is to keep track of your itemized expenses throughout the year using a
spreadsheet or personal finance program. You can then quickly compare your
itemized expenses with your standard deduction. You should always take the
higher of your standard deduction or your itemized deduction. Your standard deduction and personal
exemptions depends on your filing status and how many dependents you have. You
can increase your standard deduction and personal exemptions by getting married
or having more dependents. The best strategies for reducing
your taxable income is to itemize your deductions, and the three biggest
deductions are mortgage interest, state taxes, and gifts to charity. Take
Advantage of Tax Credits Once we've tweaked our taxable
income, we are ready to focus our attention on various tax credits. Tax credits
reduce your tax. There are tax credits for college expenses, for saving for
retirement, and for adopting children. The best tax credits are for
adoption and college expenses. Not everyone is in a position to adopt a child,
but everyone could take some college classes. There are two education-related
tax credits. The Hope Credit is for students in their first two years of
college. The Lifetime Learning Credit is for anyone taking college classes. The
classes do not have to be related to your career. You may also want to avoid
additional taxes. If at all possible, avoid early withdrawals from an IRA or
401(k) retirement plan. The amount you withdraw will become part of your
taxable income, and on top of that there will be additional taxes to pay on the
early withdrawal. One of the best, and most abused,
tax credit is the Earned Income Credit (EIC). Unlike other tax credits, the EIC
is credited to your account as a payment. And that means the EIC often results
in a tax refund even if the total tax has been reduced to zero. You may be
eligible to claim the earned income credit if you earn less than a certain
amount. Increase
Your Withholding You can
avoid owing at the end of the year by increasing your withholding. More money
will be taken out of your paycheck throughout the year, but you will get bigger
refund when you file your taxes. |