Reduce Your Federal Income Taxes: Part 2

Getting the most out of your taxes should be a top priority for every working man and woman, especially if you have a family. With a proper breakdown of your tax portfolio, you can begin taking advantage of your opportunities by following the tips below to reduce your federal income taxes:

Tax-deferred retirement plans: Whether you have access to a 401(k), a 403(b), a regular IRA, or a Keogh plan, making the most of your tax-deferred retirement plans is the fastest way to build for your future and reduce the amount of taxes you pay today. Why? Because every dollar you put into a retirement account today reduces this year’s taxable income. You may be limited in how much you can contribute to a particular plan, but you have at least postponed the taxes on that income. On the down side, you have restricted your ability to use that money until you retire. Most people should pump every dollar they can into a tax-deferred account.

Flexible spending accounts: Employers often offer flexible spending accounts, also called “cafeteria plans,” which allow you to put a certain amount of pretax dollars away to pay for medical, dental, or dependent care expenses that are not otherwise reimbursed, such as coinsurance payments or a nanny’s wages. Because these are pretax dollars, they effectively reduce your taxable income. On the other hand, these plans are usually headlined “Use It or Lose It.” If you don’t spend everything in your account by the end of the year, you lose the cash.

Mortgages and home equity loans: Every dollar you pay in interest on mortgages (up to $1 million) or on home equity loans (up to $100,000) is tax-deductible. The higher your mortgage interest, the lower your taxable income (if you qualify for itemization).

Timing is everything: You can accelerate your deductions by playing around with dates. Make one additional mortgage payment this year instead of next. If you want to boost your deductions for next year, close on your home on January 2 (or the first business day after the New Year’s holiday), and you can deduct points paid on your next year’s taxes. You may also be able to push income into the next year, which lowers your tax obligation for this year.

The tax consequences of investing: Different types of investments offer various tax advantages. Some of the best include: municipal bonds; U.S. Treasury bills, notes, and bonds; U.S. savings bonds; investment real estate; annuities; and stock. Each of these investments has pros and cons. Your dividends from a municipal bond, for example, may be tax-free, but the interest rate you earn may be lower than from other sorts of bonds.

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