Dodge the Loopholes but Lower Your Tax

1. Reduce your taxable income.

The step most readily available to the average taxpayer is retirement saving. A large number of employers now offer 401(k) retirement-savings plans, which are typically funded in part by you and in part by your employer. Money you put into one of these plans comes off the top of your pay so that it is not included when your taxes are computed. Neither is any matching contribution your employer may make.

If you are self-employed or run a business, even if it's a sideline to your regular job, there are numerous tax-saving retirement plans you can employ. Some of these are complicated, such as Keogh plans or individual 401(k) plans, and require expert help to set up. But they permit deferral of taxes on big chunks of your income, so they are worth the trouble.

If you invest outside of tax-favored accounts such as the foregoing, consider tax-exempt bonds or bond funds. Many of these pay interest that is exempt from both federal and state income taxes -- though watch out for the AMT. More on that below.

Rates on these are lower than on taxable bonds, but you may be better off after taxes are figured in.

If you know your tax bracket -- this is the tax rate on your last few dollars, not how much you pay overall -- you can do a quick check to figure out which taxable rate a tax-exempt rate is equivalent to.

To figure this, you divide the rate on the tax-exempt bond by 1 minus your tax bracket. In other words, if you're in the 28 percent bracket and are looking at a tax-exempt bond that pays 5 percent, the taxable equivalent rate is: 0.05/(1-0.28) = 6.94 percent.

In this case, the tax-exempt bond would pay you the same after tax as a taxable bond paying 6.94 percent.

Finally, if you are concerned for the safety of your savings, consider U.S. Treasury securities. Their interest is exempt from state and local taxes.

2. Control your investment income.

One of the enduring complaints of mutual fund investors is the unexpected capital gains distributions that sometimes show up late in the year. The mutual fund industry is urging Congress to allow investors to defer taxes on these distributions if they are reinvested in the fund, but such a rule hasn't passed.

But there are things you can do.