Saturday, April 23, 2011, AM | 9 Comments
Now that the tax season is over for most taxpayers, there are certain steps you can take this year to lower the tax burden next year. This article includes information about your federal income tax situation so you can plan for or take advantage of tax laws in the upcoming tax years. There are specific definition to understand so you can start working on effectively reducing your taxes next year.
I used TaxACT software for calculating and filing my federal and state taxes. At the end of this process, the software led me to a page where they specifically addressed my situation and to be prepared this year to save on taxes next year. The following is an excerpt of the article.
- Tax Rate
- Retirement Options
- Write up a Will
- Education Deduction
- Home Office
- Standard vs Itemized Deductions
Marginal Tax Rate
The marginal tax rate is the federal income tax rate that will be applied to any additional income that you might receive. For example, if your marginal tax rate is 28%, the next $100 of additional income that you earn will result in $28 of additional tax.
Effective Tax Rate
The effective tax rate is the actual percentage of your total income that you pay in federal income tax. This hopefully is a lot less than the marginal tax rate.
Save More And Save
Contributions to your 401(k) are not included in your taxable wages on Form W-2 or Form 1040. By increasing the amount you contribute to your 401(k) plan, you can save for your retirement and save on your tax bill as well.
Since your 401(k) contributions are not taxable, they are not subject to income tax withholding. If you increase your 401(k) contributions, your take home pay will not decrease by the full amount of the contribution because less withholding will be taken out of your wages.
Don’t Forget To Rollover
Putting money into a retirement plan can be a real financial advantage, but taking money out of a retirement plan before you are age 59 1/2 can be a real financial disaster. If you take money out of a retirement plan early, there is a 10% penalty on the income in addition to the normal tax you pay on the distribution.
If you are changing jobs and your employer asks if you are going to rollover your account or take the money, take the rollover. Most of the time you can roll the fund directly to your new employer’s plan. A bank, savings and loan, or brokerage, could also assist you with setting up an IRA account for your rollover. Generally, you will have 60 days after you receive the distribution to complete the rollover.
If you withdraw funds from your plan, the double whammy of the tax and the penalty can really hurt on April 15th and leave you wondering if what was left after taxes was really worth keeping the money after all.
You may be able to benefit from a deductible traditional IRA contribution. The principal benefit from the IRA contribution is being able to deduct the amount of the contribution from your income in your tax return. The second, longer term tax benefit, is that the funds inside the IRA will continue to grow tax-free, which increases the rate of return when compared to a traditional taxable investment.
IRA Contribution and Deduction Limits
The contribution limit to a traditional or Roth IRA for 2011 is now at $5,000. If you reach age 50 before 2011, this limit is increased to $6,000. Individuals that are covered by a retirement plan at work may only make deductible IRA contributions if their income is under certain thresholds. For 2011, that threshold is $66,000 if single and $110,000 if married filing jointly or qualifying widow(er).
Maximum for Retirement Plan Contributions
For 2011, the maximum amount that may be contributed to a qualified retirement plan is $16,500 ($22,000 if you are age 50 or over). For SIMPLE plans, the limit is $11,500 ($14,000 if you are age 50 or over).
Be Your Own Bank
One benefit of your 401(k) retirement plan is the ability to borrow money from your plan. When you have a serious short-term need for cash, a loan from your 401(k) is a quick, cost-effective way of borrowing, and it generally does not create a taxable event.
A loan from your 401(k) can be easier to obtain than a regular loan because there is no actual lender and no examination of your credit rating. Also, the interest you pay on the loan are added back to your 401(k), so you are paying yourself the interest.
However, a loan from your 401(k) plan may not always be your best option. When you repay the loan, you are using after-tax dollars, and then money will be taxed again when you withdraw from your 401(k) plan after retirement. The amount you can borrow from your 401(k) plan is generally limited to 50% of your vested account balance.
You should plan to stay at your job as long as you have the loan because most plans require the loan to be repaid immediately if you quit your job. Quitting your job without repayment of the loan will make the balance of the loan a taxable distribution.
Forgiveness of Mortgage Debt
The Emergency Economic Stabilization Act of 2008 allows distressed homeowners to exclude all or part of the mortgage debt forgiven on a principal residence from income. This applies for debt forgiven in 2007 through 2012. For more details on these debt relief provisions, see Form 982 and IRS Publication 4681.
Repayment of First-Time Home-buyer Credit
If you received the first-time home-buyer credit for a home purchased in 2008, you should have begun repaying the credit in 2010. This repayment must continue in 2011 and years beyond until the full amount is repaid. You may also prepay a portion of the credit if that will work best for your financial situation. In many instances if the home ceases to be your main home, the full amount remaining to be repaid must be repaid with the filing of the tax return following that change.
During the 15-year repayment period, the taxpayer’s income tax is increased by 6 2/3% of the amount of such credit for each taxable year. For example, if you received a $7,500 first-time home-buyer credit for a home purchased in 2008, you will add $500 (6 2/3% of $7,500) to your income tax liability each year for 15 years.
If the taxpayer disposes of the principal residence, or ceases to use as the principal residence, the home for which they received the first-time home-buyer credit, the repayment of the credit is accelerated. The amount of credit remaining to be repaid is added to the income tax liability of the taxpayer for the year of sale or year the home ceases to be the principal residence. If the house is sold to an unrelated person, the repayment is limited to the amount of gain (if any) on the sale.
For homes purchased in 2009 and 2010 repayment only applies if within the first 36 months the taxpayer disposes of the principal residence or ceases to use as the principal residence, the home for which they received the first-time home-buyer credit. The amount of credit remaining to be repaid is added to the income tax liability of the taxpayer for the year of sale or year the home ceases to be the principal residence. If the house is sold to an unrelated person, the repayment is limited to the amount of gain (if any) on the sale.
If you don’t have a will, your state has one for you – and it is probably not what you would have chosen. Make sure that your loved ones and assets are protected by taking the time to prepare a will. If you already have a will in place, it is a good idea to review it periodically to ensure that it is up-to-date with your financial and family information.
Confirm Your Beneficiary
Any funds left in your retirement plan at your death will pass to the beneficiaries named in the plan document. Even if you have a will that is up-to-date, the retirement plan money will generally pass to the people named on the plan document. From time to time, you should review your beneficiary information to verify it corresponds with your current situation.
Expect The Best, Prepare For The Worst
You can never fully prepare for a disaster, but there is one simple thing you can do to make things easier financially if disaster does strike. Making a home inventory complete with serial numbers and pictures of the most valuable items will make filing an insurance claim much easier and more complete in the event of a catastrophic fire or natural disaster. Make sure to keep the list somewhere safe and preferably not in your home. Take it to work, a safety deposit box, or give it to a friend or family member for safekeeping and easy recovery in an emergency.
The Interest Of Higher Education
If you have, or are considering, student loans to pay for a college education, the interest on those loans may be deductible. A maximum deduction of $2,500 is available for individuals with income less than $60,000 ($120,000 for married filing joint). The deduction is reduced at higher incomes and is completely eliminated for incomes greater than $75,000 ($150,000 for married filing joint).
Tuition and Fees Deduction
The tuition and fees deduction was extended by new legislation to apply to 2010 and 2011. In some cases the tuition and fees deduction may give you a greater tax benefit than one of the credits. However, you should evaluate the alternative tax treatments to determine which will give you the best results. Education expenses are considered automatically within the system for the American Opportunity Credit or the Lifetime Learning Credit in addition to the tuition and fees deduction.
New legislation extended for 2010 and 2011 the provisions that allowed educators to deduct up to $250 of out-of-pocket ordinary and necessary classroom-related expenses as an adjustment to income. If both spouses in a joint return are educators then each may deduct up to $250 of qualifying expenses for a total of $500.
American Opportunity Tax Credit
The American Opportunity Tax Credit, will be available for two additional tax years, 2011 and 2012. The credit continues to cover the first four years of post secondary education. Qualified expenses still include textbooks in addition to tuition and required fees. The credit continues at a maximum of $2,500, with the maximum refundable portion being $1,000. Taxpayers with an adjusted gross income of $80,000 ($160,000 if married filing joint) will begin to have their credit phased out. The phase out is complete when adjusted gross income reaches $90,000 ($180,000 if married filing joint).
The American Opportunity Tax Credit is scheduled to expire at the end of 2012. The Hope credit with its lower limitations will return for 2013 unless Congress modifies the law.
Not Less Interest for Higher Education
The new tax law extends for 2011 and 2012 the student loan interest deduction at $2,500 with higher phaseout levels. The law that would have applied in 2011 reduced the phaseout levels at a significantly lower adjusted gross income range and the loan interest deduction also would have applied only to interest paid during the first 60 months in which interest payments are required.
Put Your Children To Work
If you are self employed or have a side business, you could consider hiring your child(ren) to perform tasks for which they are qualified in your business. By paying your child(ren) a reasonable wage for their work, you can to deduct the wages as an expense from the business income. Your child(ren) can then use the money to purchase the clothes, shoes, and entertainment you may have eventually paid for anyway. Generally, your child may have total earned income up to $5,700 without having to pay any tax of their own. The key though, is they must actually perform some labor or service of value and the compensation must be appropriate for the task.
Are You Going The Extra Mile?
If you are going the extra mile to volunteer for a charity, you can deduct out of pocket expenses such as the cost of gas and oil. One example would be trips from your home to the charity. Your out of pocket expenses are deducted with your normal cash contributions. If you do not want to keep track of your actual expenses, you may opt to claim a deduction using the standard mileage rate of $.14 per mile.
Itemized Deduction Phaseout
In years before 2010, the benefit of itemized deductions has been reduced at higher income levels through a phaseout calculation. The new tax legislation stops itemized deduction phaseout for both 2011 and 2012.
Personal Exemption Amount
In 2011, you will be allowed to deduct $3,700 for each person claimed on your return.
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