CHAPTER 7:

TRIMMING YOUR TAXES

Monis, Jonathan M.
Moreño, Angelie M.
In this Chapter
 Understanding the importance of marginal tax
rates.
 Reducing employment income taxes and
increasing your deductions.
 Lowering investment income taxes.
 Tapping in to education tax breaks.
 Getting help from tax resources and handling an
adult notice.
Understanding the taxes you pay

 Some people feel lucky when they get a

refund, but all a refund really indicates is that
you overpaid in taxes during the year. You
should have had this money in your own
account all along.
Focusing on your total taxes

 Tofind out the total taxes you pay, you need to

get out your federal and state tax returns.
 Understanding the tax system is the key to
reducing your tax burden. If you don’t, you’ll
surely pay more taxes than necessary.
 The
fewer desirable activities you engage in, the
more you pay in taxes.
Recognizing the importance of your
marginal tax rate
 When it comes to taxes, not all income is treated
equally.
2009 Federal Income Tax Brackets and Rates
Singles Married-Filing- Federal Tax Rate
Jointly
Taxable Income Taxabale Income (Bracket)
$0 - $8,350 $0 – $16,700 10 %

$8,350 - $33,950 $16,700 - $67,900 15 %

$33,950 - $82,250 $67,900 - $137,050 25 %

$82,250 – $171,550 $137,050 - $208,850 28 %

$171,550 – $372,950 $208,850 - $372,950 33 %

More than $372,950 More than $372,950 35 %

Defining Taxable Income
 Notall income is taxable. Example, you pay federal
tax on the interest you earn on a bank savings account
but not on the interest you earn from municipal bonds.
 Youget to subtract deductions from your income.
Expenses, such as mortgage interest and property
taxes, are deductible in the event that these so called
itemized deductions exceed the standard deductions.
When you contribute to qualified retirement plans,
you also effectively get a deduction.
Being mindful of the second tax
system: Alternative minimum tax
 You may find this hard to believed, but a second
tax system actually exists. This second system may
raise your taxes even higher than they would
normally be.
 Thegovernment created a second tax system –
Alternative Minimum Tax (AMT)
 AMT restricts you from claiming certain deductions
and requires you to add back in income that is
normally tax free. (ex. Bonds)
Trimming Employment Income
Taxes
 You’re supposed to pay taxes on income you earn
from work. Countless illegal ways are available to
reduce your employment income – for example,
not reporting it – but if you use them, you can
very well end up paying a heap of penalties and
extra interest charges on top of the taxes you
owe. And you may even get tossed in jail.
Contributing to retirement plans
A retirement plan is one of the few painless and
authorized ways to reduce your taxable
employment income.
 Retirementplans help you build up a nest egg so
that you don’t have to work for the rest of your
life.
 Notavailable to those under the age of 18, full
time students,
Special Tax Credit for Retirement Plan
Contributions
Singles Married-Filing-Jointly Tax Credit for
Retirement
Adjusted Gross Income Adjusted Gross Income Account Contribution
$0 - $16,500 $0 - $33,000 50 %

$16,500 - $18,000 $33,000 - $36,000 20 %

$18,000 - $27,750 $36,000 – $55,500 10 %

Shifting some income

 Income shifting, which has nothing to do with

money laundering is a more esoteric tax-reduction
technique that’s an option only to those who can
control when they received their income.
Increasing your deductions

 Deductionsare amounts you subtract from your

adjusted gross income before calculating the tax
you owe.
 TheIRS gives you two methods for determining
your total deductions.
 Good news is you get to pick the method that
leads to greater deductions – and hence, lower
taxes.
Choosing Standard or Itemized
deductions
 The first method for figuring deductions requires
no thinking or calculating. If you have a relatively
uncomplicated financial life; taking the so-called
standard deduction is generally the better option.
 Itemizing your deductions on your tax return is
the other method for determining your allowable
deductions. This method is definitely more of a
hassle. Itemizing will save you money.
Purchasing real state

 When you buy a home, you can claim two big

ongoing expenses of home ownership – your
property taxes and the interest on your mortgage.
Trading consumer debt for mortgage
debt
 When you own real estate, you haven’t borrowed
the maximum, and you’re run up high – interest
consumer debt, you may be able to trade one
debt for another. You may be able to save on
interest charges by refinancing your mortgage or
taking out a home equity loan and pulling out
extra cash to pay off your credit card, auto loan,
or other costly credit lines.
Contributing to Charities

 Youcan deduct contributions to charities if you

itemize your deductions.
Remembering Auto registration fees
and state insurance
 Ifyou don’t currently itemize, you may be
surprised to discover that your state income taxes
can be itemized. When you pay a fee to the state
to register and licence your car, you can itemized
a portion of the expenditure as a deduction. The
IRS allows you to deduct the part of the fee that
relates to the value of your car. The state
organization that collects the fee should be able to
tell you what portion of the fee is deductible.
Deducting miscellaneous expenses
Most of these expenses relate to your job or career
and the management of your finances:
 Educational Expenses. You may be able to deduct
the cost of tuition, books and travel to and from
classes if your education is related to your career.
Specifically, you can deduct these expenses if your
course work improves your work skills. Courses
required by law or your employer to maintain your
position are deductible. Continuing education
classes for professionals may also be deductible.
Note: Educational expenses that lead to your moving
into a new field or career are not deductible
 Job searches and career counseling. After you
obtain your first job, you may deduct legitimate
costs related to finding another job within your
field. You can even deduct the cost of courses and
trips for new job interviews – even if you don’t
change jobs. And if you hire a career counselor to
help you, you can deduct that cost as well.
 Expenses related to your job that aren’t
reimbursed. When you pay for your own
subscriptions to trade journals to keep up with
your field or buy a new desk and chair to ease
back pain, you can deduct these costs.
 Investment and tax related expenses. Investment and
tax-advisor fees are deductible, as are subscription cost
for investment related publications. Accounting fees for
preparing your tax return or conducting tax planning
during the year are deductible; legal fees related to
your taxes are also deductible. If you purchase a home
computer to track your investments or prepare your
taxes, you can deduct that expense, too.

*When you deduct miscellaneous expenses,you get to

deduct only the amount that exceeds 2% of your AGI
(Adjusted Gross Income). AGI is your total wage, interest,
dividend, and all other income minus retirement account
contributions, self-employed health insurance, alimony
paid, and losses from investments.
Deducting self-employment expenses

 When you’re self employed, you can deduct a

multitude of expenses from your income before
calculating the tax you owe.
 Peoplesimply aren’t aware of the wonderful
world of deductions. Others are worried that
large deductions will increase the risk of an audit.
 Taking
full advantage of your eligible deductions
makes sense and saves you money.
The following are common mistakes made
by people who are their own bosses:
 Beingan Island unto yourself. When your self
employed, going it alone is usually a mistake
when it comes to taxes. You must educate
yourself to make the tax laws work for rather
than against you. Hiring tax help is well worth
your while.
 Makingadministrative tax screwups. As a self
employed individual, you’re responsible for the
correct and timely filing of all taxes owed on your
income and employment taxes on your
employees. If you have employees, you also need
to withhold taxes from each paycheck they
receive and make timely payments to the IRS and
the appropriate state authorities.
Another alternative is to hire a payroll firm such
as Paychex, to do all this drudgery for you.
 Failing to document expenses. When you pay with
cash, following the paper trail for all the money
you spent can be hard for you to do. At the end of
the year, how are you going to remember how
much you spent for parking or client meals if you
fail to keep a record. How will you survive an IRS
audit without proper documentation?
 Failing to fund a retirement plan. You should be
saving money toward retirement anyway, and you
can’t beat the tax break. People who are self-
employed are allowed to save a substantial portion
of their net income on annual basis. See Chapter
11
 Failingto use numbers to help manage business. If
you’re a small business owner who doesn’t track
her income, expenses, staff performance, and
customer data on a regular basis, your tax return
may be the one and only time during the year
when you take a financial snapshot of your
business. After you go through all the time,
trouble and expense to file your tax return, make
sure you reap the rewards of all your work; use
those numbers to help analyze and manage your
business.
 Failing to pay family help. If your children spouse
or other relatives help with some aspects of your
business, consider paying them for the work.
Besides showing them that you value their work,
this practice may reduce your family’s tax
liability. For example, children are usually in a
lower tax bracket. By shifting some of your
income to your child, you cut your tax bill.
Reducing Investment Income Taxes

 The distributions and profits on investments that

you hold outside of a tax-sheltered retirement
accounts are exposed to taxation when you
receive them. Interest, dividends, and capital
gains(profits from the sale of an investment at a
price that’s higher than the purchase price) are
all taxed.
Investing in tax-free money market
funds and bonds
 Tax free investments pay investments income,
which is exempt from federal tax, state tax, or
both.
 The earnings from tax-free investment can end up
being greater than what you’re left with from
taxable investments.
 Tax-free money market funds can be a better
alternative to bank savings accounts.
Selecting other tax-friendly
investments
 Too often, when selecting investments, people
mistakenly focus on past rates of return. Everyone
knows that the past is no guarantee of a future.
But choosing an investment with a reportedly high
rate of return without considering tax
consequences is an even worse mistake. What you
get to keep – after taxes – is what matters in the
long run.
Making your profits long-term

 When you buy growth investments such as stocks

and real estate, you should do so far for the long-
term – ideally ten or more years. The tax system
rewards your patience with lower tax rates on
your profits.
Does funding retirement accounts still
make sense?
 Historically,taking advantage of opportunities to direct
money into retirement accounts gives you two possible
tax benefits. First, your contributions to the retirement
account may be immediately tax deductible (See
Chapter 11). Second, the returns on the investments in
the retirement accounts aren’t generally taxed until
withdrawal.
 One good reason not to fund a retirement account is if
you have a specific goal, such as saving to purchase a
home or start a business, that necessitates having
access to your money.
There are only two atypical situations in which not
funding a retirement account could make sense:
1. You’re temporarily in a very low tax bracket.
Example if you lose your job for an extended
period of time or ar in school. In these cases
you’re unlikely to have lots of spare money to
contribute to a retirement account anyway.
2. You have too much money socked away already.
If you have a large net worth inside retirement
accounts, which could get hit by estate tax,
continuing to fund retirement may be
counterproductive. (See Chapter 17)
Enlisting Education Tax Breaks

 Beingso labor intensive, education is often costly.

The government recognizes this fact, as well as the
overall societal benefits from better – educated
people, and offers plenty of tax reduction
opportunities in the tax laws. Knowing that you
don’t want to read the dreadful tax code, heres a
summary of key provisions you should know about
yourself and your kids if you have them.
 Tax deductions for college expenses: You may
take up to $2,500 tax deduction on IRS Form 1040
for college costs as long as your modified adjusted
gross income (AGI) is less than $60,000 for single
taxpayers and less than $120,000 for married
couples filing jointly.
 Tax-free investment earnings in special accounts:
Money invested in Education Savings Account
(ESAs) and in section 529 plans is sheltered from
taxation and is not taxed upon withdrawal as long
as the money is used to pay eligible education
expenses. Subject to eligibility requirements you
may contribute up to $2,000 annually to ESAs 529
plans allow you to stock away $200,000+. Please
be aware, however, that funding such accounts
may harm your potential financial aid. (See
Chapter 13 for details)
 TaxCredits: The Hope Scholarship and Lifetime
Credits provide tax relief to low-and moderate-
income earners facing education costs. The Hope
credit may be up to $1,800 in cash of the first two
years of college, and the Lifetime Learning Credit,
up to $2,000 per taxpayer. Each student may take
only of these credits per tax year. And in a year in
which a credit is taken, you may neither withdraw
money from an ESA or 529 plan nor take a tax
deduction for your college expenses.
Getting Help from Tax Resources
 Allsorts of ways to prepare your tax return exist.
Which approach makes sense for you depends on
the complexity of your situation and your
knowledge of taxes.
 Regardless of which approach you use, you should
be taking financial moves during the year to
reduce your taxes. By the time you actually file
your return in the following year, it’s often too
late for you to take advantage of many tax-
reduction strategies.
IRS

 If you have a simple, straight forward tax return,

filing it in your own using only the IRS instructions
is fine. This approach is as cheap as you can get.
The main costs are time, patience, photocopying
expenses and postage for mailing the completed
tax return.
Software and Web sites

 Ifyou have access to a computer, good tax

preparation software can be helpful. TaxCut and
TurboTax are programs that I have reviewed and
rated as the best. If you go the software route. I
highly recommend having a good tax advice book
by your side.
Professional Hired Help

 Competent tax preparers and advisor can save you

money – sometimes more than enough to pay their
fees – by identifying tax-reduction strategies you
may overlook. They can also help reduce the
likelihood of an audit, which can be triggered by
blunders. Mediocre and lousy tax preparers, on
the other hand, may make mistakes and not be
aware of sound ways to reduce your tax bill.
 Four Main Types of Tax Practitioners
1. Preparers – Preparers generally have the least amount of
training of all the tax practitioners, and a greater
proportion of them work part-time. As with financial
planners, no national regulations apply to preparers, and
no licensing is required.
2. Enrolled Agents (EAs) – A person must pass IRS scrutiny in
order to be called an enrolled agent. This licence allows
the agent to represent you before the IRS in the event of
an audit. Continuing education is also required; the
training is generally longer and more sophisticated than it
is for a typical preparer. EAs are best for people who have
moderately complex returns and don’t necessarily need
complicated tax-planning advice throughout the year.
3.Certified Public Accountant (CPA) – Certified
public accountant go through significant training
and examination before receiving the CPA
credential. In order to maintain this designation, a
CPA must also complete a fair number of continuing
education classes every year.
4. Tax Attorney – Tax Attorneys deal with
complicated tax problems and issues that usually
have some legal angle. Unless you’re a super-high-
income earner with a complex financial life, hiring
a tax Attorney to prepare your annual return is
prohibitively expensive. In fact, many tax attorneys
don’t prepare returns as a normal practice.
Dealing with an Audit
 Many people are traumatized by audits because they
feel like they’re on trial and being accused of a
crime.
 You may be getting audited simply because a
business that reports tax information on you, or
someone at the IRS, made an error regarding the
data on your return.
 Audits that requires you to schlep to the local IRS
office are the most feared type of audits.
 The amount of additional tax that you owe in
interest and penalties hinges on how your audit
goes.
Getting your act together

 Preparing for an audit is sort like preparing for a

test at school. The IRS will let you know which
sections of your tax return it wants to examine.

Decision :
1. Handle it yourself
2. Hire a tax advisor
Surviving the day of reckoning

 Two people with identical situations can walk into

an audit and come out with very different results.
The loser can end up owing much more in taxes
and have the audit expanded to include other
parts of the return. The winner can end up owing
no additional tax or even owing less.
Here’s how to be a winner in your tax
audit
 Treatthe Auditor as a human being. This advice
may be obvious, believe it or not, most auditors
are decent people just trying to do their jobs.
They’re well aware that taxpayers don’t like
seeing them. Relax and be yourself. Behave as
you would around a boss you like – with respect
and congeniality.
 Stick to the knitting. Your audit is for discussing
only the sections of your tax return that are in
question. The more you talk about othe area’s or
things that you’re doing, the more likely the
auditor will probe into other items.
 Don’t argue when you disagree. State your case.
When the auditor wants to disallow a deduction or
otherwise increase the taxes you owe and you
disagree, state once why you don’t agree with her
assessment.
 Don’t be intimidated. Most auditors are not tax
genius. The work is stressful - being in a job
where people dislike seeing you is not easy.
Turnover is quite high. Thus many auditors are
fairly young, just-out-of school types who
majored in something like English, History, or
Sociology. They may know less about tax and
financial matters than you do. ( Most tax advisor
know more about the tax system than the average
IRS auditor).
THANK YOU !!!