We all complain about how many of our hard-earned dollars go to Uncle Sam. However, with a little time, research and proper planning, we can learn how to keep more of our money when tax time rolls around.
1. Use a Certified Public Accountant
I often wonder why couples will spend $200 to go out for dinner yet do their own taxes. Not only are they forgoing the wise counsel of an expert but also setting themselves up for a potential error that could cost them thousands in the long run. I always recommend clients work with a CPA in order to maximize tax planning opportunities and plan for any potential tax liabilities. Discussing your financial situation with a CPA can help you come up with a strategy that will keep more dollars in your pocket.
2. Be Educated
It’s often been said, “An educated consumer is a wise consumer.” It is important to be educated in basic tax preparation.
One of the most important tax forms you should understand is Form 1040 – the U.S. Individual Income Tax Return. Some may laugh and say it would take a master’s degree in taxation to understand that form. However, with a little knowledge, Form 1040 can certainly be demystified. Form 1040 asks you to report your income, and then gives you opportunities to reduce that taxable income or taxes paid by allowing you to take adjustments, deductions, exemptions and credits. By familiarizing yourself with those four words, you’ll have the tools that can help to reduce your taxable income.
3. Find Ways to Reduce Your Total Income
On lines 7-22 of Form 1040 sources of income are reported. Think of every line as an opportunity to plan. For instance, line 7 asks for wages. We all know contributing to a retirement plan is one of the best of ways to save for retirement. However, what you may not know is it is also one of the best ways to reduce wages.
In 2015, those 49 and under can contribute up to $18,000 to an employer-sponsored retirement plan such as a 401(k) or 403(b). Those 50 and older can contribute an additional $6,000. So if you make $100,000 and you contribute $10,000 to a 401(k) plan, guess what? You get to put $90,000 on the wages line, which means you have just reduced your taxable income by $10,000. Take the time to review each line with your CPA to see if there are additional ways to plan to reduce your income next year.
4. Take Advantage of Adjustments to Gross Income
Lines 23-37 of Form 1040 give you opportunities to lower the income you’re reporting. One of the biggest opportunities in this area is contributing to a traditional IRA. Unfortunately, not all of us can take advantage of this adjustment. In order to deduct all or part of your contributions to your IRA, your AGI, or Adjusted Gross Income, needs to be below a certain level if you are already contributing to an employer-sponsored retirement plan. For singles, that maximum threshold is $71,000. For those Married Filing Jointly the threshold is $118,000. For 2015, if your income is below those thresholds those under 49 can contribute and deduct up to $5,500. Those 50 and older can contribute and deduct up to another $1,000. Thanks to these and many more listed adjustments, often known as above-the-line deductions, taxpayers can find additional ways to reduce their taxable income.
Now that you have reduced your income as much possible, it’s time to see what is available to you in terms of deductions, exemptions and credits.
5. Choose Wisely Between the Standard & Itemized Deductions
When it comes to deductions, most taxpayers are allowed a choice between the itemized deductions and the standard deduction.
The standard deduction is a dollar amount that non-itemizers may subtract from their income and is based upon filing status. For 2015, those amounts are $6,300 for singles and those filing married separately, $12,600 for married couples filing jointly, and $9,250 for those filing head of household. Itemized deductions are a list of eligible expenses that can be tallied up and reported on the federal income tax return in order to decrease taxable income.
While it may seem easier to take the standard deduction, it is important to determine whether itemizing your deductions is the better route. Some examples of itemized deductions are medical expenses, property taxes, mortgage interest and charitable donations. It is important to review the list of itemized deductions and keep track of the amounts that fall under these categories as it could significantly reduce your taxable income.
6. Take Your Personal Exemptions
Personal exemptions are another way the IRS allows you to reduce your taxable income. This area is fairly straightforward. In 2015, one personal exemption equals $4,000. You are allowed to claim a personal exemptions for yourself, your spouse and your dependents. However, there are two things to keep in mind.
First, the IRS has rules around dependents. The dependent must be a “qualified child” or a “qualified relative.” So if you are claiming someone as a dependent, be sure and check the rules. Secondly, once your adjusted gross income reaches a certain point your personal exemption amount begins to reduce. Taxpayers completely lose the benefit of personal exemptions at $380,750 for individuals and $432,400 for married taxpayers filing jointly.
7. Tax Credits
Tax credits reduce the amount of income taxes you owe, and tend to encourage parenting, education, energy efficiency, retirement, investing and a whole host of other situations. Because tax credits don’t come along all that often in a lifetime, be knowledgeable when one does come your way. Some examples of tax credits include adopting a child, having a child, caring for an elder and making energy-efficient home improvements.
For more information on ways to reduce your taxes visit a Certified Public Accountant, a Certified Financial Planner professional or www.irs.gov.
More on Income Tax:
- How to Maximize Your Tax Refund
- Do Unpaid Taxes Affect Your Credit Report?
- Do Taxes Affect Your Credit Score?