Tax Planning

Nobody likes to pay taxes and paying more taxes than required by the law just means less money in your pocket.

There are basically 5 things you can do to reduce your incomes taxes:

  1. If you can afford to, increase the amount you contribute into your employer's retirement plan (doing this lowers your gross taxable income).
  2. Tak advantage of available tax deductions and claim available tax credits (see below).
  3. Contribute to an individual Retirement Account (IRA), if eligible, see Retirement section.
  4. Monitor your investment's unrealized gains and loses to capture potential losses that can offset gains reported on your Schedule D.
  5. Turn a hobby into a business (i.e., writing-off your expenses can lower your taxes).

To get a snapshot of your current taxes, use a paycheck analysis calculator to show you how the following events can impact the amount of taxes you pay and your take home pay:

  • What if your income changes?
  • What if the the tax law changes (again)?
  • What if the number of children you have changes?
  • What if your the amount of your itemized deductions changes?
  • What if the amount you contribute to your retirement plan changes?

Use this free paycheck analysis calculator.

Knowing your marginal income tax bracket can help you understand your tax liability for the last dollars of income you earn because as you make more income, your income tax rate goes up (see Federal Income Tax Brackets below). Estimate your average tax rate, current tax bracket and marginal tax rate, click here.

Many of the tax breaks in recent tax-relief bills were designed to be phased in over a number of years, or are indexed to inflation. To keep up with tax laws that affect your long-term tax planning, see this TurboTax article which explains changes scheduled to come into effect through 2017.

The current U.S. tax code is unbelievably complicated (the law, regulations and explanations run to over 42,000 pages), however there are opportunities for tax savings.  Knowing key tax terms is vital to finding these tax savings.

  • Gross Income - Includes employment income (W-2), interest income (1099-INT), dividend income (1099-DIV), capital gains on stocks, bonds and mutual funds (1099-B), government income such as a tax refund and unemployment (1099-G), income from annuities, pensions, IRAs, retirement plans (1099-R), social security income (1099-SS), independent contractor income, prizes/awards received (1099-MISC), and distributions from health/medical savings accounts (1099-SA).
  • Adjustments - Adjustments are expenses the IRS allows you to subtract from your gross income to arrive at your adjusted gross income (AGI), such as student loan payments (1098-E), tuition payments (1098-T), contributions to traditional IRAs, contributions to medical savings accounts, moving expenses, self-employed health insurance, contribution to a pension plan, alimony paid, educator expenses and penalties paid on early withdrawals of savings.
  • Adjusted gross income (AGI) - Is all the income you receive over the course of the year such as wages, interest, dividends and capital gains minus any adjustments to income mentioned above. Adjusted gross income is the first step in calculating your final federal income tax bill.
  • Modified Adjusted Gross Income (MAGI) - Is a measure used by the IRS to determine if a taxpayer is eligible to use certain deductions, credits and retirement plans such as the Hope Scholarship Tax Credit, Lifetime Learning Tax Credit, Student Loan Interest Deduction, Tuition and Fees Deduction, Traditional & Roth IRA eligibility and contribution levels. MAGI is calculated by taking the your AGI and adding back certain items such as foreign income, foreign-housing deductions, student-loan deductions, IRA-contribution deductions and deductions for higher-education costs.
  • Standard Deduction - This is a fixed dollar amount that you can subtract from your income. The standard deduction is available to all filers and is determined by your filing status. The amounts change each year because of inflation adjustments. This deduction method is used by most taxpayers and eliminates the need to itemize authorized IRS deductions such as medical expenses, charitable contributions and taxes (see below).
  • Itemized deductions - These are expenses that can be deducted from your AGI to help you reach a smaller income amount (if your itemized deductions are larger than your standard deduction) upon which you must calculate your tax bill. Itemized deductions include medical expenses, taxes (i.e., state, local and property tax), mortgage interest, charitable contributions, casualty and theft losses, un-reimbursed employee expenses and miscellaneous deductions such as gambling losses.
  • Exemptions - This is an amount that the IRS lets you subtract from your income to reflect all the people who count on your income. Exemptions can be claimed for yourself, your spouse and your dependents. As with deductions, exemptions are subtracted from your adjusted gross income to come up with your final, lower earnings amount upon which you figure your tax bill.
  • Taxable income - This is your gross income reduced by all allowable adjustments, deductions and exemptions. It is the final amount of income you use to figure how much tax you owe.
  • Credits - Tax credits such as daycare expenses, credit for elderly or disabled, education credit, child tax credit, residential energy-efficient property credit, saver’s credit, adoption credit, hybrid vehicle credit and the earned income credit are more valuable than deductions because rather than reducing the amount of taxed income, they directly cut the amount of tax you owe or give you a bigger refund. A $200 credit, for example, will turn a $1,000 tax bill into only $800.

The following links are useful for managing and lowering your taxes:

  • 2009 Federal Income Tax Brackets, click here
  • 2010 Federal Income Tax Brackets, click here
  • State Income Tax Brackets, click here
  • 2009 Capital Gains Tax Rates, click here
  • Free e-file your federal tax return (if your 2009 AGI <~$56,000), click here
  • Turbotax is the leading online tax preparation software, click here
  • Federal Tax Withholding Calculator, click here
  • Federal & State Tax Withholding Calculator, click here
  • Federal Tax Withholding W-4 Assistant, click here
  • Estimate your taxes calculator, click here
  • Itemize or take Standard Deduction, click here