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A Penny Saved is a Penny Earned—Save $$$ by Lowering Your Taxes

Everyone would like to spend less on taxes, and fortunately you can reduce your taxable income through various deductions or credits. Here are a few suggestions for uncovering tax breaks that may be available to you.

Stop Giving Uncle Sam Interest-Free Loans

If you got a big tax refund this year, it meant you’re having too much tax taken out of your paycheck. The average tax refund for 2010 was $3,129 (about $260 per month). That’s money that can be used throughout the year to , , or just take care of day-to-day expenses as needed. Instead, we’re allowing the IRS to take this money and use it for the year, only to return it later with no interest paid to us. Go to the payroll office of your employer and fill out a new W-4 form and adjust the withholding amounts to insure that you keep more of your money in your paychecks. The IRS has a withholding calculator available online to help you calculate the correct amount needed.

Maximize Your Medical Deductions

The IRS lets you deduct medical costs as long as they are more than 7.5 percent of your adjusted gross income. Medical and dental bills for you, your spouse and your dependents count toward reaching that adjusted gross income limit. But, be tax-smart when it’s time to pay for those medical expenses. If your employer offers medical reimbursement accounts—sometimes called a flex plan—make every effort to take advantage of it. These plans let you redirect part of your salary to an account which you can then use to pay your medical bills. This can allow you to avoid paying both income and Social Security tax on the money.

No Capital Gains on Tax-Deferred Investments

Taxpayers who can lower their tax rates significantly by shifting investment income to long-term capital gains. A capital gain is the difference between what you paid for an investment and what you received when you sold it. If you made a profit on the investment, then you have a capital gain. Many people invest in stocks, bonds, and mutual funds through a tax-deferred retirement account. Individual Retirement Accounts (IRA), Roth IRA, and 401(k) plans are examples of tax-deferred accounts. Your investment profits in tax-deferred accounts are not reported as capital gains, and therefore, bypass the capital gains tax.

If you are concerned about higher taxes in the future, consider moving your retirement plan contributions over to a Roth 401(k), if your employer offers one. As of January 2006, U.S. employers have been free to allow employees to elect the Roth 401(k) for their retirement plan contributions. Unlike a traditional 401(k), you don't get a tax break when your money goes into a Roth 401(k) (similar to a Roth IRA). On the other hand, money coming out of a Roth 401(k) in retirement will be tax-free, while cash coming out of a regular 401(k) will be taxed.

Let Uncle Sam Pay for Your First Home

Because “after tax” dollars are used to fund a Roth, all contributions can come out of a Roth at any time, tax-free and penalty-free. And, as long as the account has been opened for at least five years, up to $10,000 of earnings can be withdrawn tax-free and penalty-free for the purchase of your . Let us assume $5,000 goes into a Roth each year for five years, and the account earns an average of 8% a year. At the end of five years you would have invested $25,000, but the Roth would hold more than $31,000 (over $6,000 in capital gains)—all of which could be withdrawn tax-free and penalty-free for a down payment.

Start a Part-Time Business

Working Americans are being strangled by taxes! About a third of your hard-earned money is paid out in various forms of taxes before you even get your paycheck in your hands. So, if you really want to reduce your tax over-head, you absolutely must start ahome-based part-time business. Understand that almost all the tax codes are designed for business owners. Home-based tax deductions are similar to tax deductions of regular businesses. However, most home-based business owners can also take advantage of the home office tax deduction, which means a home-based business owner can usually deduct part of their mortgage payment for tax purposes. The amount of the tax deduction is based on the square footage of the office and home, according to the IRS’s guidelines.

Business owners, part-time or otherwise, can also save money in a self-employed retirement account; although you must have income from the business. If you have your own business, you have several choices of tax-favored retirement accounts like Keogh plans and Simplified Employee Pensions (SEPs). Contributions reduce your tax liability while the earnings grow tax-deferred.

Most parents give their children money to spend on things the kid wants, so why not get a tax deduction for that too? As an unincorporated business owner you can hire your children to work for you. You’d deduct what you pay them, thus shifting income from your tax bracket to theirs. And, if the child is under age 18, they would not have to pay Social Security tax on the earnings.

Looking for a Job? Deduct Those Expenses

Millions of Americans are unemployed today that are actively . If you’re one of them, you understand how the “cost” of looking for a job can be taxing, especially when there is no income. So, make sure you keep track of your job-hunting costs because they may be deductible. As long as you're looking for a new position in the same line of work, you can deduct job-hunting costs, including travel expenses like food, lodging and transportation, if your search takes you away from home overnight. There are limitations so check with the IRS or a tax professional for more details.

A 529 College Funding Plan Can Save You $$$

Saving money in a custodial account can save on taxes. The 529 Plan is considered one of the best options for saving for a child’s college education. The allows for after-tax contributions to be made on behalf of a designated beneficiary (not just a child) and qualified withdrawals are free of federal tax. Most plans let you save in excess of $200,000 per beneficiary, plus, there are no income limitations or age restrictions, which means, you can start a 529 no matter how much you make or how old your beneficiary. Also, if one child decides not to go to college, you can switch the account to another child or take it back.

It Pays to Self-Improve

Rather than spend your own after-tax income for , companies can offer employees up to $5,250 for educational assistance tax-free each year. That means the boss pays the bills but the amount doesn't show up as part of your salary on your W-2. The courses don't even have to be job-related and even graduate-level courses qualify.

Find a Tax Specialist/Professional

This is nowhere near a comprehensive list as there are many more deductions and credits available. Also keep in mind that everything listed is not applicable to everyone, and because tax laws change quite often, some benefits may not be available at all. So do not just take my word for it…get with a real and find out what’s appropriate and available for you.

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