Tax Strategies
How the U.S. Tax System Works
To obtain a basic understanding of the tax system, you must keep two things in mind-all income is taxable, unless you can find a specific law or regulation that says that income is not taxable, and nothing is deductible unless you can find a specific law or regulation that says that item is deductible. That’s why it’s always best to secure the services of a reputable C.P.A. or I.R.S. enrolled tax accountant. Don’t be dependent upon your own wisdom but rather that of someone who knows how to navigate the murky waters of taxes.
Use Tax Strategies, Never Tax Evasion
Tax strategies are positive, legal uses of the tax laws to reduce your income taxes. Tax strategies are actions you take that automatically and legally qualify you for additional deductions. These action strategies can include opening an IRA account, starting a small business, buying real estate and other possibilities. Some tax strategies, like those just mentioned, are straightforward and obvious. Other strategies, like traveling on tax deductible dollars and a tax deductible college education for your children, are just as legal, just as easy to use, but less understood.
Start a Business
The sooner we start a business the sooner we begin to have a fighting chance to convert personal expenses into business deductions. As a matter of fact, it’s estimated that the first year we start a business–there must exist an intent to profit–we could see somewhere between five to six thousand dollars in potential deductions!
Know this truth, “ultimately all deductions lower your taxable income.” So, whenever someone says to us I want to start a business but simply haven’t got the money, our response is “You can’t afford NOT to start a business if for no other reason than the tax deductions, that go on to lower your income tax bracket and wallah, end up financing your investment in the first place.”
Maximize Your Itemized Deductions
Since the government already gives you an automatic deduction in the Standard Deduction, you should strive to itemize on Schedule C. By buying a home and itemizing your deductions, you will automatically lower your taxes through medical expenses, taxes paid, interest, charitable gifts, casualty losses and numerous miscellaneous deductions. Expenses you already incur and pay with money that has already been taxed. By itemizing, you will be able to lower your taxes and get some of the money back.
Maximize Before-Tax Contributions to Employment Related Retirement Plans
Saving for your own retirement is a necessity. Social Security is not now, nor was it ever intended to be the primary source of retirement income. The average monthly Social Security benefit for a couple, both of whom were receiving benefits, is only about $1,400, hardly enough for a comfortable retirement.
Retirement plan contributions are also the easiest and best way to reduce taxes regardless of income. You are able to reduce your income tax liability by saving money. Most other tax deductions require you to spend a dollar to save 10% to 35% (the current range of tax brackets) in income taxes. As an additional bonus, most employers have some type of matching contributions, giving you a “guaranteed rate of return” on your investments.
Participate in Your Employer-Sponsored Cafeteria Plan and FSA (Flexible Spending Arrangement)
Many employers offer cafeteria (Section 125) plans which allow you to pay the employee share of medical or dental insurance premiums with before-tax dollars. These contributions are not subject to Social Security and Medicare tax and are made in before-tax dollars.
Contribute to a Roth IRA Rather Than a Traditional IRA
The maximum contribution to an IRA in 2006, either traditional or Roth, is $4,000 ($4,500 if age 50 or older) per person or a percentage of your earned income, whichever is less. The exception to this rule is that a non-working spouse also can make a $4,000 contribution as long as the working spouse has enough earned income to equal the combined IRA contributions. As of 2003, a traditional IRA may NOT be deductible if you are an active participant in a retirement plan at work, and if your modified adjusted gross income is less than $75,000 and you are single, or less than $55,000 and you are married. Single taxpayers can contribute to a Roth IRA if their income is less than $110,000 and married couples can contribute to a Roth IRA if their joint income is less than $160,000. If you cannot contribute to a Roth, you can still contribute to a non-deductible traditional IRA.
If Your Children Have Earned Income, Invest $3,000 in a Roth IRA for the Child
Example: Your child earns $3,000 through a part-time job. The parents or grandparents open a Roth IRA in the child’s name for $3,000. Assuming an average rate of return of 12% and no further contributions are made, this account will have grown to approximately $1,000,000 tax free by age 62 if the child started by age 13.
If the child followed this strategy and made $3,000 contributions for the years when they were 13, 14, 15 and 16 years old, their Roth IRA would grow to over $1,000,000 by age 55.
Deduct Medical Expenses for a Child or Other Person Who Qualifies as a Dependent
You can deduct all medical expenses for any person for whom you pay more than half of their support and pay their medical bills. This can be used for a spouse, former spouse, children and other dependents.
Convert Consumer Interest to Deductible Interest
Mortgages are treated differently from consumer loans when computing deductible interest. The interest is deductible on your first and second home mortgages up to $1 million of the total acquisition cost-the price you originally paid for the homes. You also may deduct the interest on up to $100,000 obtained through an equity loan, no matter what the money is used for. Interest on loans exceeding the value of the home is not deductible. For most Americans, all interest on refinancing will be deductible. Using the acquisition cost rule, you can get an equity loan on your first or second home to pay off your non-deductible debt and increase your tax refund in the process.
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If the average interest rate on these loans is 12%, one year’s interest is $3,000, but the interest is not deductible. Using a qualified home equity loan for $25,000 to pay off the loans, the interest can be lowered (7-10%) and becomes deductible. If you are in the 25% bracket, you get hundreds of additional cash dollars back in your next refund from the interest deduction, and the amount of interest that you pay would be less.
Please consult your CPA or tax attorney for guidance and anytime you implement tax strategies as the regulations constantly evolve.
Please be sure to read our disclaimer prior to acting on any information you find on this website There is never any substitute for personalized professional advice.
