When it comes to taxes, we all want to reduce the amount we have to pay in. There are three basic ways to minimize your taxes: reduce your income, increase your deductions and take advantage of tax credits.
Your Adjusted Gross Income is a key in determining your taxes. Your tax rate and tax credits depend upon your AGI. In fact, your AGI is a powerful number. Lenders will want to to know your AGI when you apply for a large loan or mortgage. If your child is to qualify for a college financial aid program, it depends upon your AGI. Your AGI is considered your true income level.
It is also where you should start your tax planning. There are many parts to your AGI. Basically, your AGI is your income from all sources minus any adjustments to your income. The higher your income, the higher your AGI. The higher your AGI, the more taxes you will pay.
It works the other way as well. If you lower your total income, you lower your AGI and the amount of taxes you pay will be lessened. This is the number one way to reduce your taxes.
How can you reduce your AGI? The best way is to contribute money to a 401(k) or similar retirement plan at work. These contributions reduce your total wages, therefore reducing your taxes bill.
You can also reduce your AGI through various income adjustments. These adjustments are simply deductions that don't have to be itemized. They include contributions to a traditional IRA and alimony paid.
You can also take a close look at your family's income situation. If one spouse earns significantly more than the other, it could be beneficial for only one to work. In many situations, a stay-at-home spouse or parent not only reduces the tax burden, but can save money through reduced work-related expenses. In my own family, my income was just enough to boost us up into a higher tax bracket -- which deducted from the benefits of working.
You can also reduce your taxes by increasing your tax deductions. Taxable income is a key element in your taxes. This is the amount left over after reducing your AGI by deductions and exemptions. Most people take a standard deduction, but quite a few people are able to itemize their deductions.
These deductions include expenses for health care, personal property taxes, mortgage interest, gifts to charity, job-related expenses, tax preparation fees and investment-related expenses.
The easiest method to itemizing your expenses is to keep record of them throughout the year using a spreadsheet or personal finance program. Then you simply compare your itemized expenses with your standard deductions. You simply take the higher deduction.
It is wise to reduce your taxable income by keeping track of your itemized deductions. The three largest deductions include mortgage interest, state taxes and gifts to charity.
So many people don't take advantage of tax credits. Tax credits reduce your tax. There are credits available for college expenses, adopting children and saving for retirement.
There are two education-related tax credits available. The Hope Credit is for students in their first two years of college, while the Lifetime Learning Credit is for anyone attending college classes. The classes can be in anything you wish -- they don't have to be related to your work or career.
Another way to limit your taxes is to avoid additional taxes. For example, an early withdrawal from an IRA or 401(k) retirement plan could result in an addition to your taxable income and penalties for early withdrawal. Not only are you reducing your retirement savings, you are increasing your tax obligation.
If you find that you have to pay in a large amount each year, you need to adjust your withholding. It will be much easier to make these payments each month rather than all at once in the spring. More money comes out of your paycheck, but you won't have to pay when you file your taxes. The goal is to be flush or have a small refund or small payment when you file your taxes.
Reducing your taxes is possible through these three simple steps. All tax planning basically falls to looking at all of your options and keeping organized records throughout the year. With a little forethought, you can lower your taxes.
