How to Lower Your
Income Taxes
The rich are there to make all the money and pay none of the
taxes. The middle classes are there to do all the work and pay
all the taxes. The poor are there to scare the daylights out of
the middle class so they’ll keep working and paying the
taxes.
George Carlin
Income taxes are the single largest expense you’ll encounter
in life, bigger then your home or the cost of getting your kids
to college. Income taxes are the prevalent barrier to real financial
security. You can never build any real wealth without first getting
your tax life under control. You may have heard the expression
“tax freedom day.” That’s the day when we stop
working for the government and begin working for ourselves.
My experience in working with thousands of families indicates
that most could substantially reduce the amount of income taxes
they pay simply by adopting a sound tax reduction plan. There
are legitimate ways to lessen your tax burden, which frees more
of your money to be used for any purpose you choose.
The sad fact is that the IRS will never tell you about a tax
deduction you didn’t claim. Discovering legitimate deductions
is up to you. Every strategy that I have explained in this free
report will reduce your taxes honestly, legitimately, and with
the full approval and blessings of the IRS.
As you read this report you may recognize tax savings that you
failed to claim when filing prior tax returns. Don’t worry.
You can go back, amend prior tax returns, and claim a tax refund.
Amended tax returns must be filed within three years from the
date you filed your original return or within two years from the
time you paid your tax, whichever is later.
Our tax system is indeed very complex, and tax laws are ever
changing. The Internal Revenue Code, the Federal Tax authoritative
guide, is a thick book with over 1.3 million words. Albert Einstein
was quoted as saying “The hardest thing in the world to
understand is the income tax.”
Generally, there are two principles in reducing your taxes:
- Make money you spend tax deductible as you spend it
- Use the power of retirement plans and investment tax shelters
Numerous strategies are identified within this chapter that you
can use to substantially reduce your income taxes. It’s important
to realize that tax planning is a year-round activity. With that
mindset, you will rethink the day-to-day business and personal financial
decisions you make relative to the tax liability they may create.
Tax Strategies vs. Tax Loopholes or Tax Cheating
In pursuing lower income taxes, it is never necessary to resort
to tax cheating or tax loopholes, or even to question the legality
of the tax system. There is a big difference between cheating, loopholes,
and strategies. This report is not about “tax loopholes”
or the “gray” (questionable) areas of tax law. It is
not about tax tricks, “tax avoidance,” or “red
flags” to get you audited. Tax strategies are positive, legal
use of the tax laws to reduce your income taxes. Tax strategies
are actions you can take that automatically and legally qualify
you for additional deductions. These deductions are IRS-approved.
And each and every one is money in your pocket. Some tax strategies
are straightforward and obvious. Other tax strategies are just as
legal, just as easy to use, but less well understood.
Strategy # 1 – Deduct your job-related auto expenses
and/or charitable mileage
When you use your automobile at your employer’s request
to run job assignments and your employer does not reimburse you,
you may deduct 34.5 cents per mile (for the year 2002). If you
are reimbursed less than 34.5 cents per mile, you can deduct the
difference. If you have a second job, the mileage between the
two jobs is also deductible.
Two methods are acceptable for deducting automobile mileage expenses.
The first, and the easier of the two to use, is the Standard Mileage
deduction. As described above, it allows you to deduct 34.5 cents
per mile. The other method is the actual expense method, whereby
you deduct the business portion of the automobile expenses such
as insurance, gas, repairs, maintenance, and depreciation.
The automobile mileage deduction is taken on Form 2106. When
reviewing past self- prepared tax returns, I come across many
people who overlooked this deduction. Naturally, the IRS never
lets them know of the missed tax savings.
You can also take deductions related to charitable gifts and
volunteer work. You can deduct travel expenses incurred by traveling
to charitable organizations for meetings, fund-raisers, or other
events. You can deduct parking and toll fees, as well as bus,
taxi, and other travel fares that are involved in doing your charitable
work.
Strategy # 2 – Deduct your job-related education
expenses
You can deduct the costs of qualifying education. This is education
that meets at least one of the following two tests:
- The education is required by your employer or the law to
keep your present salary, status, or job. The required education
must serve a bona fide business purpose of your employer.
- The education maintains or improves skills needed in your
present work.
However, even if the education meets one or both of the above
tests, it is not qualifying education if it
Is needed to meet the minimum educational requirements
of your present trade or business, or
- Is part of a program of study that will qualify you
for a new trade or business.
- You can deduct the expenses for qualifying education even
if the education could lead to a degree.
Deductible expenses. The following education-related
expenses can be deducted.
- Tuition books, supplies, lab fees, and similar
items.
- Certain transportation and travel costs.
- Other educational expenses, such as costs of research
and typing when writing a paper as part of an educational program
Strategy # 3 – Deduct a home-based office when
used for your employer
People who work for companies whose headquarters or branch offices
are not located in the same city as the employee, or outside salespeople
who often use their home office as a base, can often use these
deductions. Even employees who do administrative paperwork in
addition to their regular duties that require an outside office
environment can use their expenses as a deduction.
There are rules that must be followed in these cases, however.
- The office in your home has to be your primary office - you
can't have another office at your employer's regular business
location.
- Your home office must be used to meet with customers, vendors,
or patients.
- Your home office must be in an area of your home that is set
aside regularly and exclusively for that purpose. The regular
and exclusive business use must be for the convenience of your
employer and not just appropriate and helpful in your job.
Strategy # 4 – Take deductions for capital losses
If you have capital gains on your investments, you can take any
capital losses against those gains and pay no tax on your positive
investment returns. Even if you have no capital gains from investments,
you can still take up to $3,000 of capital losses against your
ordinary income. The trick is in defining capital gains and losses.
For instance,
money that you get back from an investment that is simply a return
of your original principal does not qualify as a capital gain.
You traditionally receive dividends that include return of principal
from such investments as real estate investment trusts (REITs)
or utility stock investments.
Strategy # 5 – Fund your retirement plans to
the maximum
Retirement planning and estate planning tips
There are many ways you can reduce your tax liability through
putting aside money for your retirement and planning wisely for
the transfer of your estate. Investing in tax shelters can pay
off handsomely in the long term. Within certain limits, you can
deduct the contributions you and your wife make to IRA accounts.
If you qualify for a Roth IRA, you can save a tremendous amount
in taxes in your later years.
By investing in a Roth IRA, you are able to take advantage of
the compounding effects of your investment returns on a tax-free
basis. In addition, you do not have to pay any taxes on the money
you withdraw after age 59½. You cannot deduct your contributions
to this type of IRA, but, as you can see from the table below,
you come out with a much greater advantage by allowing your returns
to compound tax-free for the years to come.
The power of tax-deferred
compounding
Assumes a 28% tax bracket, a constant 8% annual
return, a $1,200 annual investment in the tax-deferred retirement
plan (before taxes), and an $864 annual investment ($1,200 before
taxes withheld) in the comparable taxable savings plan. This example
reflects federal income taxes only. This illustration does not
represent the performance of any particular investment. Your results
may be more or less. Retirement assets will be taxed eventually
(upon withdrawal), and there may be a 10% federal tax penalty
for withdrawals made prior to age 59½.
There are limits to how much income you can make and still be
able to contribute to a Roth. But if you are below those income
thresholds, you should contribute as much as possible to your
Roth. Even if your income begins to go beyond the threshold as
you become more successful, you can put aside as much money as
possible in a Roth while you still qualify. At least you will
have the advantage for that pool of funds.
After your income goes beyond the threshold, there are other
tax shelters you can use for your retirement. You can contribute
to a 401(k) program, or you can take advantage of a defined benefit
or defined contribution program your employer may have set up.
Many employers have done away with their defined benefit and defined
contribution plans as a result of the more popular 401(k) plans.
This is because their liability is less with a 401(k) than with
either of the other plans.
With a defined contribution plan, employers are bound to a specific
percentage contribution of the company’s profits to the
employees. If the company experiences a down year, it must find
a way to make that contribution no matter what. In a defined benefit
plan, the employer guarantees the benefits of the plan to you
as an employee. That means that no matter what happens in the
investment markets or the economy, your employer is bound to give
you a specific amount of benefit for your retirement.
It’s easy to see why employers would choose a 401(k) over
the other two plans. Many employers provide matching contributions
to some degree to 401(k) contributions after you are “vested,”
or after you have stayed with the company for a certain number
of years. But you must be careful to find out whether you are
allowed to make other investments than in the company’s
stock. Many investors have lost their entire retirement nest eggs
by having their 401(k) plans invested only in one thing - usually
the company’s stock where they are employed.
Hopefully, investors will have learned from this mistake and
will be more careful to diversify their investments both inside
and outside of their 401(k) plans.
Self-employment options
If you are an independent contractor or if you own your own company,
you have a few other tax shelter choices. One of these is a Simplified
Employee Pension plan, or aSEP plan. You can tuck away a significant
portion of your income in these and other plans such as Keoghs,
within certain limits. You can contribute up to 13 percent of
your income in a SEP and other profit-sharing plans and up to
20 percent in Keogh and defined contribution plans. You can shelter
a total of $30,000 per year in a mix of these types of plans.
If you are en entrepreneur, a doctor, lawyer, writer, entertainer,
or other such entrepreneurial professional, more than likely you
can set up one or more of these types of plans. If you have a
partner, you can use a Keogh plan, but you must also establish
pension plans for your employees.
Strategy # 6 – Gifting assets to your children
You can gradually take money out of your estate by giving it
away. If your estate is larger than the normal exclusion amount,
you can reduce its value by giving away $11,000 per year to each
of your children, grandchildren, or anyone else without paying
federal gift taxes. Your spouse can gift money as well, thus allowing
a total $22,000 gifting capability between the two of you each
year per recipient.
For very financially affluent individuals, these gifts are an
excellent way to help with the educational needs of their grandchildren
or to pass on their legacy without paying undue taxes. One note:
if you use $11,000 worth of stock as your gift, give the stock
shares away; do not sell the stock first and give the sale proceeds.
Why? If you use the stock itself as the gift, you give a much
more valuable gift to the recipient. He or she will have to pay
taxes on the value of the gift at the time it was given, but the
gift of stock can go on appreciating to much more than the original
$11,000 value.
Or, if you are giving the gift to a child under age 14, you can
give the stock, then let the child sell it under his or her tax
rate instead of yours, which will be a much higher tax rate than
the child’s. The best thing, though, is to give the stock
and allow it to appreciate into a much more valuable long-term
gift for the child. This will help make the most of the gifts
you give for the child’s college education, especially if
the child is very young and several years will before the money
will be needed.
Strategy # 7 – Write-offs for children's summer
camp
Day camp costs are eligible for the child-care tax credit and
employer-sponsored “flexible spending arrangements”
(FSA). Many working parents who are sending their younger children
to day camp this summer can count on the tax code to help subsidize
part of the cost.
For children under age 13, the cost of day camp is eligible for
the child and dependent care tax credit. Sending a child to day
camp is also an eligible expense for employees who are paying
child-care expenses through flexible spending arrangements at
work.
Only day camp costs count. The cost of sending a child to sleepover
camp isn't eligible for either the child tax credit or payment
through flexible-spending accounts.
The child- and dependent-care credit covers expenses for the
care of children under age 13 (or an incapacitated dependent of
any age) while the parents are at work. Generally, the credit
applies to expenses of up to $2,400 a year for the care of one
child and up to $4,800 for two or more dependents.
FSAs also provide tax savings. Any salary set aside in an FSA
to pay eligible dependent-care expenses is exempt from income
tax and Social Security tax.
Strategy # 8 - Choose an aggressive and knowledgeable
tax preparer or none at all
Whether you use a tax preparer is strictly a matter of choice.
Almost 65 percent of taxpayers use a tax preparer, and with the
complexity of the new tax laws, more and more help will be needed.
A good tax preparer is hard to find. He or she is an aggressive
tax preparer who is up-to-date on all the new tax laws and their
interpretation. Such a tax preparer can help you rethink your
tax situation in light of the new tax laws, guide you through
financial transactions, and, most importantly, inform you of new
tax-saving opportunities and alert you to dangerous tax traps.
Strategy # 9 – Filing amended tax returns
Finding hidden treasures in prior years’ returns is a very
exciting process. Most taxpayers are afraid that they’ll
trigger an audit if they file an amended return. This fear, which
is common and understandable, prevents many taxpayers from getting
refunds they are entitled to.
The truth about amended returns is that they are not an automatic
invitation to an audit Very few, in fact, are ever audited. Many
types of amendments are processed routinely.
Some amendments are safer than others. The audit rate for amended
returns, while higher then that regular returns, is still quite
low. You can minimize the risk of an audit by sending back-up
documents with your 1040X (the form used for making amendments).
Make note that when you amend your federal tax return, your state
tax liability from that year may be affected, too. It could lead
to an even bigger tax refund.
Do You Engage in Tax Planning Year-Round?
Many people worry about their taxes only during tax season. However,
you will save a fortune in taxes, legally, if you make tax planning
your year-round concern.
Can you make some changes to turn your hobby into a moneymaking
business? Can you use that extra room in your house as a home
office for your business? Can you arrange to use your car more
for business purposes, and have you documented your business use
mileage? Can you arrange for more of your entertainment expenses
to be business related? Have you listed the business purpose on
each receipt?
Do you make business and personal purchases, investments, and
other expenditures with tax savings in mind? Do you document your
expenses well so that they would survive a tax audit? Whenever
you are faced with a business or personal financial decision,
do you consider the tax consequences?
Make year-round tax planning part of your business management
mindset and thus enjoy maximum tax savings. By rearranging your
affairs to account for tax implications, you will save a fortune
in taxes. Call us at (732) 566-3660 if we can help or visit us
on the web at www.njtaxsavers.com
My final word of tax advice
Changes in tax laws in this country are ongoing. Enjoy the potential
tax savings through implementing some of the tax breaks and strategies
that I have identified in this report while these breaks exist.
Don’t miss the boat (yacht)!!!
“Of course, lower taxes were promised, but that has
been promised by every president since Washington crossed the
Delaware in a rowboat. But taxes have gotten bigger and their
boats have gotten larger until now the president crosses the Delaware
in his private yacht.”
Will Rogers, 1928
Return to Free Articles Page
|