The Best Ways to Reduce Your Taxes

Tuesday, Apr 10, 2007

You may be paying higher taxes than you need to. Find out how to use the system to your advantage, and keep Uncle Sam out of your pocketbook.

Wouldn't you love to give less money to the taxman? Wouldn't we all like to receive a larger tax refund? The good news is that you can lower your tax bill significantly by putting some TLC into your IRS April 15th filing. The bad news is that it takes a bit of work. However, you'll find that it's well worth the effort.

Deductions

You don't need to take a pay cut just to reduce your taxable income. That's what deductions are for. The standard deduction is the easy way out and for some of us, it's the best choice. But if you own a home and pay mortgage interest, itemized deductions are the way to go. It's a little more effort to gather the information about interest and property taxes paid, but real estate can boost your deductions well beyond the standard take. Don't forget to include qualifying interest payments from second mortgages, too.

Another way to reduce the part of your paycheck that Uncle Sam can reach is to contribute to tax-deferred retirement accounts. The options are legion: traditional IRAs, 401(k)s, 403(b)s, Keoghs or SEP IRAs, depending on your employment and preferences. You can deduct a few thousand dollars' worth of contributions to these plans, and the deductible amount is rising every year.

And that's far from all. Once you itemize, you'll find a plethora of available deductions. It might be a good idea to invest in tax preparation software or a professional tax service to make sure that you don't miss anything.

Credits

Tax credits are even more valuable than tax deductions, as they count against the actual tax paid rather than just the income used to calculate your tax bill. If you're in the 25 percent tax bracket, a credit is worth four times as much as a deduction of the same size.

Credits, however, are not as common as deductions. There's the child tax credit, which removes $1,000 from your total taxes for each of your eligible children. There's also the low-income benefit known as the Earned Income Credit; the two higher-education tax credits, Hope and Lifetime Learning; and a smattering of more unusual tax credits related to energy efficiency and adoption expenses, to name a few.

Again, some professional tax help doesn't hurt. The tax code is complicated, and once the 1040EZ form is left behind, only the foolhardy or the masochistic will attack the IRS forms without so much as a software package to help. You can save a lot of money, so it's worth the investment.

Finally, don't forget to adjust your withholdings for next year. Ideally, you'd be close to break even on your next tax return. A fat refund might feel good, but that money is better off generating interest for you than sitting around in Uncle Sam's federal bank account.

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