Top 15 Things Every Taxpayer Should Know
All income, generally speaking, is subject to income tax. But not all money you receive is considered taxable income. Examples of what's not taxable: inheritances, life insurance proceeds, borrowed money, gifts, and child support payments.
1. Taxable Income
2. Your Tax Bracket
Think of tax brackets as a row of buckets with one bucket for each bracket. Your income fills the lowest-rate bucket first, then the next bucket, then the next. Each bucket of income is taxed at its own specific rate. Entering the next bucket does not cause all your income to be taxed at the new rate, only the amount that flows over from the previous bucket. Your "top tax bracket" is the last bucket that has income in it, and that's the rate at which the next dollar you earn will be taxed.
Where you hold investments matters. Hold investments that produce taxable income in tax-deferred accounts. Hold those that produce tax-free or tax-favored income in your regular accounts.
4. Tax Records
You're required to keep records to substantiate the income and deductions you report on your tax return. Organized records will make tax filing easier, and they'll be a help in tax planning to cut your tax bill.
Even if you don't itemize deductions on your tax return, you may be entitled to certain "above-the-line" deductions (those that are subtracted from your income to arrive at your adjusted gross income). They include such things as IRA contributions, student loan interest, moving expenses, health insurance if you're self-employed, and alimony paid.
5. Certain Deductions
In taxes, a credit is better than a deduction. A credit reduces your taxes dollar for dollar (i.e., a $1,000 credit cuts your taxes by $1,000). A deduction reduces your taxes by your tax rate percentage (i.e., a $1,000 deduction for someone in a 15% tax bracket cuts taxes by $150).
6. Credit vs. Deduction
7. Marital Status
Your marital status can have a major impact on your taxes. Sometimes changing the date for a wedding or the timing of a divorce can be a major tax saver. A divorce certainly requires some tax planning. How you structure support payments, who gets to claim the tax exemptions for dependent children, and how you split up assets can make a huge tax difference to both parties.
Making contributions to a retirement fund is one of the best shelters around. A traditional IRA can provide deductible contributions and tax-deferred growth. Roth contributions are not deductible, but qualified withdrawals are completely tax-free.
8. Retirement Fund
9. Tax Breaks
Many deductions and credits disappear once income reaches certain levels. By knowing what tax deductions and credits you might qualify for, you may be able to do tax planning that will preserve your eligibility for these income-sensitive tax breaks.
Home is where the tax savings are. You can deduct mortgage interest and property without taxes, paying and you taxes can on sell your home without paying taxes on the appreciation in value (up to certain limits), as long as you meet the ownership and use requirements.
10. Your Home
11. Age Matters
Many tax provisions are linked to age, so whenever there's a birthday in your family, check for changes your tax planning should take into account.
When you sell anything for a profit, the gain is generally taxable, but when you sell at a loss, you're not necessarily entitled to a deduction. A loss on a home sale, for example, isn't deductible, and net capital losses have an annual limit (though you can deduct the excess loss in future years).
12. Gains and Losses
13. Dealing with the IRS
File tax returns on time. If you can't meet a filing deadline, request an extension.
• Notify the IRS when you have an address change.
• Amend a return if you discover that you've missed income or a deduction after filing. (You have up to three years from the original filing date to amend.)
• Don't ignore communications from the IRS; if you do, things will only get worse.
• Don't fall for tax scams. There is no secret way to avoid paying taxes.
You can give a limited amount of property or money to individuals tax-free. There's an annual limit on the amount you can give to any one individual and a lifetime limit on other gifts. However, there is no limit on certain kinds of gifts; gifts to your spouse and payments for the medical or educational expenses of another person made directly to the medical or educational institution.
14. Tax-Free Gifts
15. Decisions and Taxes
Don't let the tax tail wag the economic dog. Don't do things solely for tax reasons; every transaction should have economic merit apart from taxes.