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Preparing your tax return is strenuous and can be a little bit tricky. Some people oftentimes even decide to not be thorough with their preparation just to get it over with; however, this is a huge mistake. People should be very careful when preparing their tax returns to make it work to their advantage. It is important to know that there are different types of income which do not have the same income tax rates. Each are taxed differently and knowing how much you have to pay for each kind of income will help you figure out the best way to reduce your tax bills not only for this year but for the upcoming years as well.

1. Ordinary income- This type of income is usually the one which has the highest income tax rate. The set of tax brackets which range from 10 percent to 39.6 percent apply in your total taxes. Included in this category are wages, salaries, business income, money you earn from property rentals and interest payments. Aside from those, you also need to remember that short-term capital gains, investments and dividend income get taxed at ordinary income tax rates. There are actually some criteria to qualify for lower rates, if you are eligible, you can take advantage and apply for them whenever possible.

2. Tax-free income- Believe it or not there are actually some investments that provide tax-free income. Of course, the ideal tax rate is zero and the most common ones which have absolutely zero tax rates are municipal bonds which are issued by the state and local governments. Now, there are also investments which start off as taxable then eventually transform into tax-free income. Retirement savings plans such as Roth IRAs make all interest, dividends and capital gains tax-free when you withdraw some money out during your retirement. In the same way, 529 plans also become tax-free when used for educational purposes.

3. Dividends and long-term capital gains- Dividends actually qualify for a preferential tax rate—meaning they get taxed at different rates depending on how much tax you pay. For those people who are included in the top-bracket tax payers, the preferential tax rate is actually 20 percent. On the other hand, those in the lowest tax brackets pay absolutely nothing in taxes while those in between usually pay 15 percent. Regarding long-term capital gains, they are actually taxed in the same manner. If you decide to sell an investment at a profit which you have had for more than a year, the profit you earn from selling your investment gets taxed at the same rates as dividends do.

4. Income from sales of collectibles- Gains that you earn from selling your collectibles which might include coins, stamps and other precious metals such as bullion and silver are not eligible for the low long-term capital gains rates which dividends and year-long investments are eligible for. In fact, a 28 percent maximum rate is imposed on gains earned from collectibles. You can be thankful though if your ordinary income tax rate is less than that, because, if it is indeed lower, then you can benefit from having to pay the lower tax rate instead of the 28 percent maximum rate.

5. Know your taxes- It is highly important that you know your tax deductibles and tax rates when preparing your tax return so that you do not end up paying more and so you can effectively figure out the different methods which can help you trim your tax bills.

Knowing the different types of income and income tax rates can be really beneficial to tax payers. By having the correct knowledge you are now faced with various options that you can take advantage of. You can apply for lower tax rates whenever an opportunity arises and you now know that you can either pay your ordinary income tax rate or the tax rate imposed on gains from your collectibles depending on which is lower. Furthermore, by simply knowing that different types of income are taxed differently, you can now make thorough plans about where and when to invest your money. In this way, you can make taxes work to your advantage by choosing investments which have favorable rates that will in turn reduce your tax bill. Make sure to check your credit report and score so you can not only effectively prepare your tax return without missing on any important details but so you can create your investing strategy accordingly to your finances as well. By learning the different income and tax rates mentioned above, you can be assured that your tax bill will look better than last year’s bill.