Making Tax-Wise Financial Decisions
Think about how much of your income goes toward taxes. If you're in the higher tax brackets, you may be handing nearly half of every dollar you earn to Uncle Sam, but there are things you can do to keep more of your hard-earned money. Good tax planning is a year-round activity. Decisions you make during the year about spending, borrowing, and investing impact your taxes at the end of the year.
Reducing Your Taxes
One of the easiest ways to reduce your taxes is to take advantage of tax-free or tax-deferred employer-provided fringe benefits, such as:
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Benefits provided under cafeteria plans and flexible-spending accounts that allow you to take benefits in lieu of cash (tax-free)
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Medical and accident insurance paid by your employer (tax-free)
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Educational assistance programs (tax-free)
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Retirement plans such as 401(k) and 403(b) that allow you to make contributions (tax-deferred)
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Incentive stock options (tax-deferred)
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Employee stock purchase plans (tax-deferred)
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Group term health insurance up to $50,000 (tax-free)
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Transportation subsidies such as mass transit incentives (tax-free)
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Employer-provided meals and lodging under certain circumstances (tax-free)
Owning a home is another one of the best tax shelters available. Not only do you get to deduct your mortgage interest from your taxable income, you also get to keep up to $250,000 ($500,000 for married couples) of profit when you sell, without paying any taxes on the gain.
Another way to reduce taxes is to be sure you take all the credits and other tax reductions you're entitled to, such as the child credit (in addition to claiming the child as a dependent), education credits, head of household status, or earned income tax credit if you qualify.
Taking Advantage of Tax-Saving Strategies
You can save money by taking advantage of a few tax-saving strategies and making sure you take all the deductions you're entitled to. Bunching and accelerating deductions are two time-honored approaches to cutting taxes. Both require an awareness of what your tax situation is before the end of the year. If you're close to being able to itemize, bunching your deductions may put you over the threshold.
Bunching is a strategy that involves timing your payments of deductible expenses by pushing as many deductions as possible into one year. When you bunch, you fatten up your deductions for one year and slim them down the next year, or vice versa. If you're close to having enough medical expenses to meet the 7.5 percent of income requirement, and there's a medical procedure you're planning, having it before the end of the year could put you over the limit and reduce your taxes.
Most people have too much tax withheld from their paychecks and get a refund at the end of the year. In 2006, the average federal tax refund was $2,379. That's roughly $200 per month that could have paid down debt or been deposited into a retirement account.
Accelerating deductions is similar to bunching, but you increase your deductions in the current year by paying tax-deductible bills that aren't actually due until the following year. For example, pay your property taxes before the end of the year instead of waiting until they're due in the following year, to push the deductions into the year you'll be able to take advantage of them.
