When you’re about to file your tax return, it’s too late to adjust your income because the tax year is already behind you. But if you plan ahead and understand what strategies there are for reducing taxes owed, you can earn tax breaks in the future. Tax planning begins with identifying your AGI. You can determine your AGI by completing IRS Schedule 1, which walks you through the steps. The form tallies up all of your anticipated sources of income in Part I, other than wages or salaries from which taxes are already withheld. It then adds up your anticipated adjustments to income—a form of tax deduction—in Part II. Enter these numbers plus your W-2 income from employment, if any, on the corresponding lines of Form 1040 to arrive at your taxable income. At this point, you’re ready to take some tax-planning steps to reduce this amount to a lower tax bracket, if possible. This can result in owing the IRS less, as well as possibly receiving or increasing a tax refund. Numerous tax breaks are available to reduce your AGI, and you can further reduce your taxable income by claiming certain credits and tax deductions that you can subtract from your total AGI. Find detailed descriptions of the most commonly used ways to reduce your AGI, below.
Tax Credits
Tax credits subtract directly from the amount you owe the IRS when you complete your tax return. Unlike deductions, they don’t simply reduce your taxable income. Some are even refundable, so the IRS will send you money if the credits you claim reduce your tax bill to below zero. Available tax credits include:
American Opportunity Tax CreditChild and Dependent Care CreditChild Tax CreditEarned Income Tax CreditCredit for Elderly or DisabledLifetime Learning Tax Credit
Let’s look at the American Opportunity Tax Credit as an example. Eligible students receive this credit for qualified education expenses they paid in the first four years of their higher education. Each student receives a tax credit of up to $2,500 each year. Tax planning for this specific credit might involve paying spring semester tuition and fees for yourself, your spouse, or a dependent in December to claim the credit for that tax year, rather than waiting until January. This could help if you think you’ll be in a higher tax bracket in the current year.
Itemizing vs. the Standard Deduction
As mentioned, taxable income is what is left over after you subtract any eligible deductions, including the standard deduction, from AGI. The majority of taxpayers take advantage of the standard deduction, but itemizing is another option, as it may lower your income more. Generally, if your itemized deductions are greater than the standard deduction, it’s best to itemize. Standard deductions for 2022 are:
$25,900 for married taxpayers filing joint returns$12,950 for single taxpayers and married taxpayers who file separate returns$19,400 for heads of household
For 2023, standard deductions are:
$27,700 for married taxpayers filing joint returns$13,850 for single taxpayers and married taxpayers who file separate returns$20,800 for heads of household
Retirement Contributions
Contributions to an IRA can be subtracted from your income on line 19 of Schedule 1, reducing your AGI, up to certain limits. You won’t pay taxes on the portion of your income that you save, but the tax bill will eventually come due when you withdraw the money in retirement. In this case, tax planning defers taxes to a time when you stop working and may well be in a reduced tax bracket.
Examples of Tax Planning
The most common methods of tax planning include claiming the most advantageous deductions and credits you’re eligible for and making sure you’re not hit with a surprise tax bill when you complete your tax return. This can be as simple as double-checking the tax withholding from your paychecks, particularly if you’ve experienced a significant life change such as gaining or losing a dependent. For those who are self-employed or have investment income, you might want to collect income this year rather than next year if you expect that you’ll be in a higher tax bracket going forward, therefore paying a higher percentage in taxes than you are currently. Likewise, you might want to postpone receiving some income if you believe you’ll be in a lower tax bracket next year.
What Tax Planning Means for You
The bottom line of tax planning is knowing what deductions and credits are available to you, and whether you meet the rules for claiming them. They all come with detailed, qualifying criteria that you must meet, and these rules can sometimes change from one year to the next. That said, the IRS is set up to help you understand them and keep on top of them. You can subscribe to IRS Tax Tips to receive emails about tax law changes and for tax-planning suggestions. To sign up, go to IRS.gov or use the mobile app IRS2G0.
