The best way to reduce your tax bill is to lower your income. There are many ways to do this. For example, you can take a pay cut (not recommended), contribute to a retirement plan, or make itemized deductions. Every dollar that you lower your income will lower your taxable income. Depending upon your tax bracket, you can save from .10 to .28 cents for every dollar that you decrease your income.
This reduction is somewhat phased out for higher-income taxpayers. However, the phaseout is being phased out. The phaseout affects taxpayers with an adjusted gross income (AGI) of more than $156,400 ($78,200 for married couples who file separate returns). This phaseout reduces your itemized deductions by 3% of the amount that your adjusted gross income exceeds the threshold listed above. For 2007, however, this reduction is reduced. This means that your itemized deductions are higher than it would be under the old rules. It seems complicated, but TaxCut will handle the calculations correctly.
If you’re affected by the phaseout, you’ll have a bit of a tax increase. This is because you can’t take the full amount of your itemized deductions, which means that more of your income is subject to income tax.
However, this phaseout doesn’t affect all deductions. It doesn’t affect medical expenses, casualty and theft losses, gambling losses and investment interest expenses. These deductions are deductible in full as entered on the Schedule A.
Note that if you are subject to the phaseout, the amount on line 28 of Schedule A won’t equal the total of all the amounts on the form. This is confusing, but correct. The adjustment is done on a worksheet.
Medical expenses include quite a few of the expenses that you pay out-of-pocket to get medical care. However, for medical expenses to be deductible, they need to add up to more than 7.5% of your adjusted gross income (AGI). Unfortunately, this means that only taxpayers with extremely large, unreimbursed medical expenses can take advantage of this deduction. To learn more, see Medical and Dental Expenses.
You’re allowed a deduction for any state and local income taxes that you paid, but you must take the deduction in the year that you paid them. However, if the amount is larger, you can opt to deduct any state and local sales taxes that you paid during the year instead. To learn more, see State and Local Income Taxes.
You can deduct the state and local real estate taxes that you pay on your home, condominium, or other property. You can also deduct the tax that you pay on personal property, such as your car. A personal property tax, also known as an excise tax, is based upon the value of the item. To learn more, see Real Estate and Personal Property Taxes.
You can take qualified mortgage interest as a deduction on both your main home and a second home if you itemize deductions on Schedule A. In addition, for the loan interest to be deductible, you must be legally liable for repayment of the loan.
You can deduct the interest on the mortgage that you pay to the bank or mortgage company on both your main home and a second home. You can also deduct interest that you pay to an individual, such as the seller of the home, if they financed the sale. As long as the loan is secured by your main home or a second home, the interest is deductible. To learn more, see Interest on Home Mortgages.
When you borrow money to have money to invest, the interest that you pay is deductible. However, the amount of investment interest that you can deduct can’t be more than the amount of investment income that you report. To learn more, see Investment Interest Paid.
Some deductions, known as miscellaneous deductions, are subject to a 2% limit. This means that they must add up to more than 2% of your adjusted gross income (AGI) before you can deduct them. To learn more, see Deductions Subject to the 2% Limit.
You can deduct money and item donations—that you make to qualified organizations. Money donations are donations that you make using cash, a check, a credit card, payroll deduction, or automatic withdrawals from your bank account. Item donations are donations of some type of goods, such as clothing, toys, household items, or even a car. In addition, you can also deduct mileage that you drive if it’s directly related to charitable work. To learn more, see Charitable Donations.
There are amounts that you enter on Schedule A that don’t fall under any of the categories listed above. These are items listed as miscellaneous expenses that aren’t subject to the 2% limit. These expenses include:
Amortizable bond premiums. A bond premium is the amount over face value that you pay for certain bonds.
Gambling losses. You’re limited to the amount of gambling winnings that you had. For example, if your winnings totaled $100, then you can deduct up to $100 in losses.
Federal Estate Tax on Income in Respect of a Decedent. For information about this deduction, see the Miscellaneous Deductions chapter of IRS Publication 17, Your Federal Income Tax.