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.

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, reduce your
income, increase your deductions, and take advantage of tax credits.

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.

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,
and 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 credits 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 You’re 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.

We can do some tax planning for you.

Please don’t hesitate to contact us about doing some Tax Planning for you and your
company. You can even do so up until January 15 2013.

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