First and foremost in determining how to reduce your taxable income is understanding what is considered taxable income and being well versed in what allowable tax deductions are available to you. [See related article “What Is Taxable Income?”]
It is also important to understand individual income taxes so that you know what to expect each filing season. [See related article “Income Tax Basics”]
There are several ways to reduce your taxable income, and thus, reduce the amount of income taxes you will owe to the IRS. This article explains some of the ways you can do this.
Income Tax Reduction ― Option #1
Knowing your filing status, anticipated annual taxable income, and whether you’re eligible to contribute to your 401(k) by employer deductions each pay-period, can help you decide how much to contribute to your 401(k). In 2009, the IRS’s maximum allowable contribution to an individual 401(k) was $16,500. Additional “catch-up” contributions were available to those aged 50 and older to a maximum of $5,000.
For example, let’s say you are age 53 with an anticipated annual salary of $67,000 and you qualify as “head of household.” With no contribution to your 401(k), your income tax would be $11,602.50 for calendar year 2009. However, if you are able to contribute the maximum allowable amount of $21,500, your income tax (with no other tax deductions) would be $6,227.00. That is a savings of nearly $5,400.00 in federal income tax, and a major contribution to your retirement account. It is also interesting to note that the 401(k) plan has a much higher contribution upper limit than the IRA plans.
Income Tax Reduction ― Option #2
If you work out of your home, a portion of your homes expenses can be allocated to office expenses ― either the square footage of the room(s) allocated for conducting business as a percentage of the square footage of your home, or the number of room(s) allocated for conducting business as a percentage of the total number of rooms.
As an example, let’s say you use a 12 x 12 foot room as your office, and one-fourth of your 25 x 25 foot garage for warehousing goods. The total area of your home is 3,000 square feet. In this instance, a little over 10% of your homes available area is used in conducting your business. That means that 10% of your mortgage loan payment, utilities, home upkeep, etc., can be deducted as business expenses. (For more information on using your home for business, consult IRS Publication 589.)
Income Tax Reduction ― Other Options
Since itemized tax deductions can include medical, dental and healthcare expenses, as well as prescriptions and the mileage to and from your doctors’ appointments, it is wise to save your receipts and keep track of your mileage. Even grocery receipts with purchases for over-the-counter medication for allergies, colds, indigestion, all are tax-deductible.
Itemized deductions also include deductions for interest paid on mortgage loans and/or investments, personal losses due to theft or accident, state and local income or sales taxes, property taxes on real estate as well as personal property, cash contributions to church or charities (and/or the monetary value of non-cash contributions to church or charities), gambling losses (provided they are offset by gambling winnings), and home office expenses. Bottom line, keep those receipts!!!
Click HERE to file your income taxes online.