The objective of tax planning is to arrange your financial matters in such a way where it is you are not required to pay so much in the way of taxes. There are three basic methods used in the reduction of taxes—those being: a) The reduction of income, b) An increase in the amount of deductions, and c) The use of tax credits. The following tax tips, relative to effective tax planning and correspondent to the appropriate tax reduction method are provided below.
Tax Reduction Method One: Decrease income in order to save on taxes
The AGI, also referred to as adjusted gross income is a key component in the determination of taxes. There are other factors, too, which determine your AGI such as tax credits taken, and associative tax rate. Your adjusted gross income also effects your life outside of paying your taxes. In example, banks, credit unions, mortgage brokers, and financial aid programs—relative to college are all interested in your adjusted gross income. AGI is clearly a financial measure of your ability to pay back loans and your financial picture, overall.
Start your tax planning initiative relative to your AGI. Ask yourself the question: What precisely goes into my AGI? In way of definition, your adjusted gross income or AGI is your gross income from all sources minus any adjustments to income. So: in light of the preceding fact, the higher your total income, the higher is your AGI. Also, not surprising, the more income you make, naturally, the more you will pay in the way of income taxes. Going in the opposite direction: if your income is low, then correspondingly, you pay less in the way of taxes.
Tip One: Reduce your income:
Reducing your income is the best way to reduce taxes. The tip or advice is not to necessarily make less of an income but to reduce your income. In example, a very good way to reduce your overall income is to contribute part of it to a 401 (k) plan or another type of retirement plan. Generally, 401 (k) plans are offered by many employers. The 401 (k) contribution not only reduces your earnings; but also decreases the taxes you owe for the year.
Tip Two: Reduce AGI by way of various adjustments to income:
Adjustments to income are deductions. You do not necessarily need to itemize the adjustments you make to your AGI by way of a Schedule A. Instead of using a Schedule A, you may make adjustments to your adjusted gross income on page one of your 1040 tax return. Adjustments are inclusive of: a) retirement contributions to a regular IRA; b) the interest paid on a student loan; c) alimony paid; and d) school related expenses. You may attain a list of adjustments by way of the IRS Form 1040, page one, lines 23 through 34. The best way to reduce your AGI, in the form of a tax deduction is to contribute to a traditional IRA. Also, it is advised you take as many deductions as you are allowed accordant to the page one, 1040 list of adjustments (just-mentioned).
At minimal best: the two most effective and significant ways to reduce your AGI is to contribute to an employer sponsored 401 (k); or a traditional IRA.
Tax Reduction Method Number Two: Increase your deductions
The income which is taxed is another significant factor in assessing your overall circumstances with regard to payment of income taxes. The taxable income is what it is you have left after reducing your adjusted gross income by way of exemptions and deductions. Almost every citizen is able to take the standard deduction; and some others are able to itemize deductions.
Tip One: Itemize deductions by way of a spreadsheet throughout the year
Deductions you may itemize include: a) health care expenditures; b) local and state taxes; c) taxes on personal property; d) mortgage interest; e) charitable donations; f) expenditures related to the job; g) tax return preparation fee; and h) expenses relative to investments. Therefore, a very good way to implement a tax planning strategy is to itemize your expenses. You may track your allowable, itemized expenses by way of an electronic spreadsheet.
Tip Two: Compare the expenses you have itemized with that of your standard deduction—include the amount which is highest on your tax return
At the end of the year, you may make a quick appraisal of your itemized expenses in comparison to what it is you may take for your standard deduction. You will wish to take whichever is higher: itemized expenses, or standard deduction.
The largest itemized deductions include: a) state taxes, b) mortgage interest, and c) charitable contributions
Tax Reduction Method Number Three: Make use of tax credits
Once you have adjusted your taxable income to some extent, you may place your focus on tax credits. Tax credits are available for: a) retirement savings, b) college expenditures, and c) adoption of children. The tax credits which offer the taxpayer the greatest advantage in reducing taxable income are relative to: a) adoption of children, and b) expenditures with respect to a college education.
Tip One: Take a college class in order to make use of the Lifetime Learning Credit; or Hope Credit
Tip Two: Adopt children, if you are in a position to do it.
Suffice it to say, not every taxpayer is set up to adopt children; however, a vast majority can certainly benefit from additional education. Two educational tax credits exist, those being: a) the Hope Credit for students in their first two years of advanced schooling; and b) the Lifetime Learning Credit which is available to anyone who takes a college course. Also, a bonus with regard to the latter credit is the classes you take do not need to be tied to your career.