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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
- Use exemptions and deductions.
- Reduce your withholding.
- Take advantage of tax credits.
- Try to spend less.
- 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 $4,300 for a single person,
$7,200 for married couples filing a joint return, $3,600 for
married couples who file separately, and $6,350 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.
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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.
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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.
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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.
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Type of Tax Credit
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Maximum Per Year
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Phase out begins for AGI more than:
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Child tax credit for dependents under
17
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$500 each
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$75,000 single
$110,000 joint filers
$55,000 married, filing separately
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Child and dependent care expenses
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$1,440
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30% of expense up to $10,000 income, 20%
of expenses for incomes more than $28,000
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Elderly or disabled
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$1,125
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Depends on income and age of you and your
spouse
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Hope Scholarship Credit (can only be used
during the first 2 years of school)
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First $1,000 and 50% of next $1,000 of
college expenses
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$40,000 single
$80,000 joint filers
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Lifetime Learning Credit
(Can't be used with Hope Credit, but can
be used for more than two years)
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20% of qualifying expenses up to $1,000
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$40,000 single
$80,000 joint filers
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Adoption
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$5,000 each; $6,000 for children with
special needs
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$75,000
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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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