When arranging your financial affairs, you will want to plan to minimize your taxes as much as you can.
Unless of course, you enjoy paying taxes. Didn’t think so.
There are three simple strategies to reduce your taxes, all with multiple variations but those methods are increasing your deductions, minimizing your income, and taking advantage of tax credits.
It’s not rocket science but emphasizes the importance of having tax planning goals when you approach your entire money situation.
SIDENOTE: If you need help filing your taxes, check out the list of my favorite tax preparation software below:
Table of Contents
Minimizing Your Income
The Adjusted Gross Income (AGI) is an important measure of your finances.
Many things are dependent upon your AGI such as your tax rate and what tax credits you are eligible for.
Your AGI affects your involvement with banks, applications for mortgages, and financial aid for colleges. Your AGI is determined by subtracting any adjustments from your income from your total income from all sources. The higher your total income is, the higher your AGI will be.
Similarly, the more money you earn, the more taxes will be deducted from your income. Alternately, the less money you earn, the fewer taxes will be deducted from your income. To reduce the amount of taxes that are deducted from your income, you have to make less.
One good way to do that is to invest money in your 401k or some retirement plan through your employer. The investment will lower your wages and therefore lower your tax bill.
Another method is to set up a Flexible Spending Account (FSA) at work or sign up for Dependent Care Reimbursement (DCR) if you have children who attend daycare. The FSA allows you to deduct part of your income tax-free in order to pay for qualified medical care expenses such as co-pays, medical equipment, and deductibles.
The DCR works in the same manner. You request an amount of your income be taken out pre-tax and are reimbursed for daycare expenses.
Don’t Forget the IRA
Another good way to lower your tax bill is to invest in a traditional IRA. I know what you’re thinking. But Jeff, you’re so in love with the Roth IRA, why would you suggest the traditional?
In some cases, for higher wage earners, it makes more sense to get the immediate tax deduction vs. the potential tax-free growth. If you’re not sure, definitely talk with your tax professional to find out.Need to open an IRA? Check out the best places to open an IRA. Right now one of my favorites is Betterment.
Maximize Your Tax Deductions
Taxable income is another way to lower your tax bill. Taxable income remains after you have lowered your AGI with exemptions and deductions. Most people get standard deductions but most people are also eligible for itemized deductions such as:
- Fees to prepare taxes either with a tax preparer or the computer programs
- Mortgage interest
- Student expenses
- Car registration fees
- Health care expenses
- Charity gifts
- Expenses related to job
- Investment-related expenses
Making Good Use of Tax Credits
Tax credits are a good way to reduce taxes that you owe. Examples of tax credits are saving for retirement, college fees, and expenses incurred for adopting a child.
Ways to avoid additional taxes being charged to you is to refrain from withdrawing from an IRA or retirement fund early. Any amount that you withdraw becomes part of your taxable income and you will be required to pay additional taxes on the early withdrawal.
Raise Your Withholding Amount
You can request from your employer to increase your number of withholding. The less withholding you claim, the more taxes will be taken out with zero being the least amount claimed. Since the most amount eligible will be taken out with claiming zero, the larger your tax return will be.
Lessening the tax headache requires spending some time analyzing your overall situation. You cannot do your tax planning goals on April 14th – it doesn’t work that way.
My wife and I meet with our CPA at minimum times per year to make sure that we keep ourselves organized and to make sure that our goals haven’t changed.
Is your tax situation a little more complex? Watch my video regarding why you should hire a CPA below:
How about you? How much time do you strategically plan your tax goals?
The Bottom Line
Effective tax planning is crucial for minimizing your financial burden and optimizing your income. By employing strategies such as increasing deductions, reducing income, and utilizing tax credits, individuals can significantly decrease their taxable amount. Investment in retirement plans, setting up Flexible Spending Accounts, and contributing to IRAs are practical steps for reducing adjusted gross income.
Maximizing deductions through itemizing and taking advantage of various tax credits can further alleviate tax liabilities. Engaging in consistent and proactive financial reviews, preferably with a tax professional, ensures that you stay on top of your tax situation, preventing last-minute hassles and ensuring financial stability.