Strategies for Reducing Your Taxes

Michael Woloshin: 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.

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.

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.

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.

Originally Posted:https://www.thebalance.com/tax-planning-basics-3193487