Basic Tax Planning

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Basic Tax Planning

No matter your income level or investment expertise, tax planning is essential to reducing your taxable income and preserving your wealth. And these basic techniques are easy to learn, and straightforward to implement.

 
Highly Effective and Easy Steps to Reduce Your Taxes
  1. Use exemptions and deductions.
  2. Reduce your withholding.
  3. Take advantage of tax credits.
  4. Try to spend less.
  5. Use a retirement account.

Tax Saving Strategy #1: Use exemptions and deductions

The biggest, easiest, and simplest way to reduce your tax bill is through exemptions and deductions. Everyone who files taxes takes advantage of at least some of these but perhaps not as many as they should.

Exemptions are the amount you can subtract from your income, thereby reducing the portion of your income that can be taxed (simply for being alive, married, and/or having kids, or more precisely, dependents).

For instance, if you were single and claimed no dependents in past years, you could reduce your taxable income by $2,700 by claiming yourself as an exemption. Check with www.irs.gov for this years’ current deductions.

Deductions are personal expenses that the government allows you to subtract from your income. You can take your deductions in 1 of 2 ways: either as a standard or an itemized deduction.

A standard deduction is a set amount that the government allows you to take. In the past years, it was $6,300 for a single person or married couples who file separately, $12,600 for married couples filing a joint return, and $9,250 for a head of household. Check with www.irs.gov for this years’ current deductions.

If you itemize your deductions, you separately list (and must document) all the deductions you qualify for and their amounts. Since you get to choose which deduction you’re going to take, the trick is to figure out which of these options gives you the highest deduction.

Deductible items can include interest on home mortgage and property taxes, donations to charities, as well as state and other forms of local income tax (including auto registration fees).

Depending on the situation, you can also deduct medical expenses, certain work-related expenses, bad debt, and the value of goods that are either destroyed by natural disasters or stolen (some limits apply).

Generally, if you are not self-employed and/or your return is simple, the standard deduction will probably be higher. If you have purchased a home, had major medical expenses, or made other major changes in your life, you may be better off by itemizing.

Tax Saving Strategy #2: Reduce your withholdings

How would you like a year-long interest-free loan? Your tax return represents an annual, interest-free loan to the government.

Your tax return calculates the amount of money that you overpaid, but the government does not have to pay you interest for that extra money that it had all year.

To minimize the size of your tax return, have your employer withhold the exact amount of tax that you will owe for the year.

Why? Because if you pay more taxes during the year, you miss out on income you could have received from investing that money.

But don’t reduce your withholding too much. If too little is withheld during the year (less than 90% of your income tax), you could face penalties for underpayment of taxes charged, plus interest.

Tax laws change every year, so you could be withholding too much or too little. To find out, consult: www.irs.gov

For example, in the past, these were tax credits available. Check with www.irs.gov for the new tax credits.

Tax Saving Strategy #3: Take advantage of tax credits

You may qualify for certain tax credits that are subtracted from your taxable income. Consider the tax credits in the past that were available. Consult www.irs.gov for this years’ current tax credit.

Type of Tax Credit

Maximum Per Year

Phase out begins for AGI more than:

Child tax credit for dependents under 17

$1000 each

$75,000 single

$110,000 joint filers

$55,000 married, filing separately

Child and dependent care expenses

Up to $3,000 for one dependent, or up to $6,000 for more than one

30% of expense up to $10,000 income, 20% of expenses for incomes more than $28,000

Elderly or disabled

$1,125

Depends on income and age of you and your spouse

Hope Scholarship Credit (can only be used during the first 2 years of school)

$2,500 per student, per year

$80,000 single

$160,000 joint filers

Lifetime Learning Credit

(Can’t be used with Hope Credit, but can be used for more than two years)

Up to $2,000 credit per return

$65,000 single

$130,000 joint filers

Adoption

$13,400

Phase out will begin at $201,010  

From $241,010, no credit.

Tax Saving Strategy #4: Try to spend less

One of the largest tax expenses you pay every day is on consumer goods, food, etc. By spending less, you pay less in sales tax. This may not sound like a big deal, but if you were to spend $3,000 less a year at a 6% sales tax, you would save $180 in taxes.

Tax Saving Strategy #5: Use a retirement account

In our Retirement Planning section, we discuss the tax-deferred benefits of a retirement plan to your overall tax savings. Not only do these accounts help preserve your future, but they also save you from having to pay Uncle Sam. Read about these tax-deferred benefits in more detail.

 

 
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