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.
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.
You can also reduce your Adjusted Gross Income through various adjustments to income. Adjustments are deductions, but you don’t have to itemize them on the Schedule A. Instead, you take them on page 1 of your 1040 and they reduce your Adjusted Gross Income. Adjustments include contributions to a traditional IRA, student loan interest paid, alimony paid, and classroom related expenses. A full list of adjustments are found on Form 1040, page 1, lines 23 through 34. The best way to boost your adjustments is to contribute to a traditional IRA.
As you can see, two of the best ways to reduce your taxes is to save for retirement, either through a 401(k) at work or through a traditional IRA plan. Contributions to these retirement plans will lower your taxable income, and lower your taxes.