As you manage your taxes with both the near and distant future in mind, one important, constant goal will be to reduce your adjusted gross income (AGI), which equals your gross income (salary, investment earnings, etc.) after your allowable deductions and exemptions. Maximizing your deductions and exemptions, as well as taking advantage of any tax credits available to you, is a great way to start thinking about saving money on your next tax bill.

Credits vs. Deductions
First things first: How is a tax credit different from a tax deduction? A tax credit reduces your tax, dollar for dollar--that is, a $1,000 tax credit actually saves you $1,000 in taxes. By comparison, a tax deduction reduces your taxable income, but it is only worth the percentage equal to your marginal tax bracket. For instance, if you are in the 25% marginal tax bracket, a $1,000 deduction saves you $250 in tax (.25 x $1,000), which is $750 less than the savings with a $1,000 tax credit. The higher your tax bracket, the more a deduction is worth, but a credit is always worth more than a dollar equivalent deduction.

Tax credits reduce your tax bill, but certain restrictions, such as income limits, may apply. If you have dependent children, you may be eligible to claim a $1,000 child credit (for 2007) for each child under the age of 17. Other family-related credits include the adoption credit and the dependent care tax credit. If you are funding a child's education, or your own, you may be eligible for the Lifetime Learning Credit or the Hope Scholarship Credit. The Lifetime Learning Credit, which applies to both undergraduate and graduate education costs, covers 20% of the first $10,000 in expenses. The Hope Scholarship Credit provides a maximum tax credit of $1,650 in 2007 for college education expenses incurred during a student's first two years.

All taxpayers may claim either a standard deduction or itemize deductions for personal expenses such as home mortgage interest. Income limits apply to taxpayers who itemize deductions. In general, a taxpayer claims an itemized deduction when the total of qualified deductible expenses exceeds the standard deduction, or if the taxpayer does not qualify for the standard deduction. For tax year 2007, the standard deduction is $5,350 for single filers and $10,700 for joint filers.

How is a deduction different from an exemption? Personal and dependent exemptions are reductions in gross income in addition to the standard deduction or itemized deductions. Every taxpayer may claim a personal exemption for him or herself, unless he or she is claimed as a dependent on another taxpayer's return. A married couple filing a joint return can claim two personal exemptions, one for each spouse. Even if one spouse has no income, that spouse is not considered the "dependent" of the other spouse for tax purposes. Exemptions will decrease for high-income taxpayers with AGIs above a certain phase-out threshold.

Above-the-Line Deductions
Retaining as much of your gross income as possible should be an ongoing objective, not something that happens only at tax time. Above-the-line deductions, if you qualify, reduce your adjusted gross income. They are so named because they are taken on your tax form just above the line where you enter your AGI. Possible deductions include contributions to qualified retirement accounts, student loan interest, alimony, early withdrawal penalties, moving expenses, and part of the cost of a new, environment-friendly hybrid vehicle.

Long-Term Capital Gains and Dividend Reform
As an investor, planning your tax strategy ahead of time can have a significant impact on your tax liabilities, particularly since the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) offered significant long-term capital gains and dividend tax relief through 2008. The Tax Increase Prevention and Reconciliation Act (TIPRA) extends these rates through 2010. For investors in the top four income tax brackets, the long-term capital gains rate has been reduced from 20% to 15%. Qualified corporate dividends will also be taxed at 15% instead of the investor's marginal rate, which prior to JGTRRA could have been as high as 38.6%.

For investors in the 10% and 15% brackets, a 5% tax rate applies to both long-term capital gains and qualified dividends through 2007, and a 0% rate will apply from 2008-2010. For planning purposes, it is important to note that JGTRRA makes no changes to the taxation of short-term capital gains, which will continue to be taxed at the investor's marginal rate.

To prepare an effective tax solution, advance planning is key. After all, the filing deadline is never too far away, and the sooner you begin planning, the greater your savings opportunities will be. Talk to your tax professional to create strategies that are right for your situation.