Whether you are traditionally-employed, self-employed or a business owner, you will have personal taxes to pay each year. Some may think that entrepreneurially-minded people may be more motivated to lower their tax liability, but they may only be masters at reducing business taxes.

On the other hand, employees are supposedly willing to take a standard deduction and withholding, thereby giving the government an interest-free loan until they get their refund the following year; but they may also be taking advantage of other tax-deferment opportunities that the self-employed or business owner may not consider (see “Your Health and Future Can Lower your Taxes” for more information).

Additionally, many taxpayers simply hand off the responsibility of tax preparation and finding tax savings off to a tax professional, accountant, or CPA. Even though they may be well-schooled in tax savings or even tax law, you know your expenses and earnings. Understanding how you the activities you pay for relate to taxes may help your tax professional find more tax savings strategies for you.

Either way, all tax payers should be motivated to (legitimately) reduce their personal tax liability. There are three ways your income, tax rate, or total tax payment may be reduced, including deductions, exemptions, and tax credits.

Tax Deductions

Deductions are what most people think of when they think about how to reduce their tax liability. There are two types you can claim on your taxes. First, the standard deduction is the set amount you deduct from your taxes if you don’t want to itemize your expenses. The amount varies if you’re single, head of household, married, over 65, or you meet other qualifications. However, if you think that your total tax-deductible expenses will exceed the standard deduction amount you can claim, then itemize your deductions.

If you’re unsure, you may get even more out of itemizing. For instance, if you are a homeowner, the mortgage interest you pay in one year will most likely be more than the standard tax deduction, which will allow you to take more deductions for qualified travel, healthcare costs, charitable contributions, etc.

Tax Credits

In addition to tax deductions, there may be credits you can qualify for that will reduce your tax liability directly. With tax deductions, the total deductible amount is taken from your income, before your tax bracket rate is applied to calculate your taxes due. Conversely, a tax credit is taken after your tax payment is calculated, thereby reducing your tax liability.

Often, tax credits can work in tandem with a deduction related to the same expense. For instance, you can deduct the amount contributed to an IRA in a given tax year up to $4000, and you may also qualify for a retirement savings credit.

Exemptions

Finally, you can reduce your taxes through exemptions, provided that you meet the income limits to qualify. There are flat-rate exemptions you can take for each qualified person in your household (you, your spouse, and dependents). If you qualify, you can make use of these exemptions regardless of whether you itemize or use the standard deduction.

You should always consult a tax professional for more details about the tax deductions and tax savings strategies you can take advantage of personally or in business. After all, professional services are also tax deductible; see “Equipment, Expenses, and Professionals for Hire: More Small Business Tax Savings” for more tax-reducing deductions that may also work if you are an employee.

References

Financial Planning. Reduce Your Income Taxes

Dianne Molving. Credits and Deductions Save You Tax Dollars

Untitled. Roy Lewis