Tax
Planning
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.
At
Penney and Associates, we are committed to providing
the best possible service so your law related needs
are handled with the utmost professionalism.
|
