Reducing Your Taxes For Dummies E-Book

Eric Tyson

• Herausgeber: John Wiley & Sons
• Kategorie: Ratgeber
• Sprache: Englisch

Seitenzahl: 482

Veröffentlichungsjahr: 2024

Beschreibung

Get year-round insight on reducing tax burdens

This book walks you through the best strategies for reducing your personal tax burden and keeping more dollars in your pocket. If you plan and manage your finances all year round, tax season can be a cakewalk. Reducing Your Taxes For Dummies offers tips on maximizing your deductions, minimizing your income tax, and hunting for breaks on investment, real estate, and business income tax. Written by Dummies financial guru Eric Tyson (Personal Finance For Dummies, Taxes For Dummies), this guide explains tax basics, savings plans, retirement accounts, and myriad ideas for reducing your personal tax burden.

• Understand filing status, child tax credits, alternative minimum tax, IRS audits, and beyond
• Avoid common tax mistakes and identify all your possible deductions
• Plan and invest in a tax-wise way throughout the year
• Make the most of your retirement accounts and savings plans

Keep your hard-earned cash with Reducing Your Taxes For Dummies. It's full of year-round opportunities for reducing your tax burden and paying less in taxes each year.

Leseprobe

Reducing Your Taxes For Dummies®

To view this book's Cheat Sheet, simply go to www.dummies.com and search for “Reducing Your Taxes For Dummies Cheat Sheet” in the Search box.

Table of Contents

Cover

Title Page

Copyright

Introduction

About This Book

Foolish Assumptions

Icons Used in This Book

Beyond the Book

Where to Go from Here

Part 1: Tax Reduction Basics

Chapter 1: Understanding the Taxes You Pay

Focusing on Total Taxes

Recognizing the Importance of Your Marginal Tax Rate

Defining Taxable Income

Being Mindful of the Second Tax System: Alternative Minimum Tax

Noting the Forever Changing Tax Laws

Chapter 2: Trimming Your Taxes

Reducing Taxes on Work Income

Increasing Your Deductions

Lowering Investment Income Taxes

Enlisting Education Tax Breaks

Getting Help from Tax Resources

Dealing with an Audit

Part 2: Personal Finance and Taxes

Chapter 3: Making Tax-Wise Personal Finance Decisions

Including Taxes in Your Financial Planning

Taxing Mistakes

Comprehending the Causes of Bad Tax Decisions

Chapter 4: Maximizing Your Retirement Account

Funding Your Retirement Accounts

Gaining Tax Benefits

Naming the Types of Retirement Accounts

Taxing Retirement Account Decisions

Chapter 5: Children and Taxes

Raising Kids

Navigating Education Tax Breaks and Pitfalls

Being Aware of Taxes on Your Kids’ Investments

Chapter 6: Reducing Estate Taxes

Figuring Whether You May Owe Estate Taxes

Reducing Expected Estate Taxes

Part 3: Your Investments and Taxes

Chapter 7: Minimizing Your Taxes When Investing

Taming Your Taxes in Non-Retirement Accounts

Tapping into Tax-Reducing Investment Techniques

Uncovering Tax-Favored Investments to Avoid

Analyzing Annuities

Selling Decisions

Chapter 8: Understanding Your Investment Choices

Slow and Steady Investment: Bonds

Building Wealth with Ownership Vehicles

Off the Beaten Path: Investment Odds and Ends

Shunning Gambling and Get Rich Quick Vehicles

Chapter 9: Investing in Funds

Understanding the Benefits of Mutual Funds and Exchange-Traded Funds

Exploring Various Fund Types

Selecting the Best Funds

Deciphering Your Fund’s Performance

Evaluating and Selling Your Funds

Part 4: Small Business Tax Reduction

Chapter 10: Small Business Taxes 101

Valuing Year-Round Tax Planning

Noting How Corporate and Individual Tax Reform Impacts Small Business

Understanding How Businesses Are Taxed

Chapter 11: Choosing Your Business Entity

Sole Proprietorships

Deciding Whether to Incorporate

One Step Further: S Corporations

Partnerships

Limited Liability Companies (LLCs)

Chapter 12: Trimming Small Business Taxes

Keeping Track of Your Small Business Revenues and Costs

Keeping Good Tax Records for Your Small Business

Calculating Whether a Deduction Is Worth Itemizing

Checking Out the New, Simplified Home Office Deduction

Deducting Health Insurance Costs

Finding Tax Breaks for Minority-Owned Businesses and Those in Low-Income Areas

Part 5: Tax Breaks in Real Estate

Chapter 13: Getting Tax Advantages from Your Home

Surveying Real Estate Tax Breaks

Purchasing Your Humble Home

Making Tax-Wise Mortgage Decisions

Selling Your House

Chapter 14: Evaluating Real Estate as an Investment

Understanding Real Estate’s Income- and Wealth-Producing Potential

Recognizing the Caveats of Real Estate Investing

Comparing Real Estate to Other Investments

Thinking about Asset Allocation

Chapter 15: Looking at Tax Considerations and Exit Strategies

Understanding the Tax Angles

Considering Exit Strategies

Taking in a Final Note on Taxes on Your Profits

Part 6: The Part of Tens

Chapter 16: Ten Overlooked Opportunities to Trim Your Taxes

Make Your Savings Work for You

Invest in Wealth-Building Assets

Fund “Tax-Reduction” Accounts

Make Use of a “Back-Door” Roth IRA

Work Overseas

Check Whether You Can Itemize

Trade Consumer Debt for Mortgage Debt

Consider Charitable Contributions and Expenses

Scour for Self-Employment Expenses

Read This Book, Use Tax Software, Hire a Tax Advisor

Chapter 17: Ten (Plus One) Tax Tips for Military Families

Some Military Wages May Be Tax-Exempt

Rule Adjustments to Home Sales

Tax Benefits for Your Family if You’re Killed in Action

Deadlines Extended During Combat and Qualifying Service

Income Tax Payment Deferment Due to Military Service

Travel Expense Deductions for National Guard and Reserves Members

No Early Retirement Distribution Penalty for Called Reservists

No Education Account Distribution Penalty for Military Academy Students

Military Base Realignment and Closure Benefits Are Excludable from Income

State Income Tax Flexibility for Spouses

Deductibility of Some Expenses When Returning to Civilian Life

Index

About the Author

Connect with Dummies

End User License Agreement

List of Tables

Chapter 1

TABLE 1-1 2024 Federal Income Tax Brackets and Rates

Chapter 2

TABLE 2-1 Special Tax Credit for Retirement Plan Contributions

Chapter 4

TABLE 4-1 2024 Tax Credit for the First $2,000 in Retirement Plan Contributions

Chapter 7

TABLE 7-1 Federal Tax Rate (2024) on Stock Dividends and Long-Term Capital Gains

Chapter 12

TABLE 12-1 The Simplified Option versus the Regular Method

Chapter 14

TABLE 14-1 How a Rental Property’s Income and Wealth Build Over Time

Chapter 15

TABLE 15-1 Calculating After-Tax Cash Flow

TABLE 15-2 Calculating Total Gain or Loss on Sale

TABLE 15-3 Adjusted Basis Calculation

TABLE 15-4 Capital Gain from Appreciation

TABLE 15-5 Total Tax Liability Calculation

TABLE 15-6 Substituted Basis Calculation in an Exchange

List of Illustrations

Chapter 6

FIGURE 6-1: State estate and inheritance taxes.

Guide

Cover

Table of Contents

Title Page

Copyright

Begin Reading

Index

About the Author

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Reducing Your Taxes For Dummies®

Published by: John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, www.wiley.com

Copyright © 2024 by Eric Tyson and John Wiley & Sons, Inc., Hoboken, New Jersey

Media and software compilation copyright © 2024 by Eric Tyson and John Wiley & Sons, Inc. All rights reserved.

Published simultaneously in Canada

No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without the prior written permission of the Publisher. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, [phone], fax [phone], or online at http://www.wiley.com/go/permissions.

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ISBN 978-1-394-24572-7 (pbk); ISBN 978-1-394-24574-1 (ePDF); ISBN 978-1-394-24573-4 (epub)

Introduction

Welcome to Reducing Your Taxes For Dummies. These pages answer both your tax-planning questions in plain English and with a touch of humor.

About This Book

In this book, I introduce the tax planning essentials that can help you legally reduce your income tax bill. I also help you keep your mind on your taxes — and strategies to reduce what you owe — while you plan your finances for the upcoming year and the years ahead.

As you probably know, Congress and political candidates engage in never-ending discussions about ways to tinker with the nation’s tax laws. Where appropriate throughout the book, I highlight how any resulting changes may affect important decisions you’ll need to make in the years ahead.

In some chapters of this book, I mention particular tax forms. If you need to look up a tax form or print one out, simply go to www.irs.gov and type the form name in the Search box.

For instructions on filling out tax forms, please see the most recent edition of my co-authored book Taxes For Dummies (Wiley). Depending on your situation, you may choose to hire a tax professional.

Foolish Assumptions

I’ve made some assumptions on how you may want to use this book. Here are the various practical ways that I figure you will use Reducing Your Taxes For Dummies to legally reduce your taxes:

As a reference:

For example, perhaps you’re interested in saving in a retirement account or purchasing investment real estate but don’t know where to begin or the tax issues to consider. Simply use the table of contents or index to find the right spot in the book with the answers to your questions. On the other hand, if you lack investments — in part because you pay so much in taxes — this book also explains legal strategies for slashing your taxes and boosting your savings. Use this book year-round.

As a trusted advisor:

Maybe you’re self-employed and you know that you need to be salting money away so that you can someday cut back on those long workdays. Turn to

Chapter 4

, and find out about the different types of retirement accounts, which one may be right for you, how it can slash your taxes, and even where to set it up.

As a textbook:

If you have the time, desire, and discipline, by all means go for it and read the whole shebang. And please drop the publisher a note and let me know about your achievement!

Icons Used in This Book

To help you find the information you need to reduce your taxes, I’ve placed icons throughout the text to highlight important points.

This icon points out stuff too good (and too important) to forget.

This nerdy guy appears beside discussions that aren’t critical if you just want to know the basic concepts and get answers to your tax questions. However, reading these gems can deepen and enhance your tax knowledge. And you never know when you’ll be invited to go to a town meeting and talk tax reform with a bunch of politicians!

This target marks recommendations for making the most of your taxes and money (for example, reduce the income taxes on your investment earnings by spending more on pickleball gear).

This alert denotes common, costly mistakes people make with their taxes.

Beyond the Book

To access this book’s Cheat Sheet, go to www.dummies.com and enter “Reducing Your Taxes For Dummies Cheat Sheet” in the Search box. There you will find the key themes that I emphasize throughout this book.

Where to Go from Here

Where you go from here is up to you. If you’re newly considering your tax planning strategy, I recommend that you read straight through, cover to cover, to maximize your knowledge of “taxable income” and explore the year-round planning that can help you reduce the taxes you owe. But the A-to-Z approach isn’t necessary. If you feel confident in your knowledge of certain areas, pick the topics that you’re most interested in by skimming the table of contents or by relying on the well-crafted index at the back of the book.

Part 1

Tax Reduction Basics

IN THIS PART …

Make sense of the federal income tax system.

Determine which tax-trimming options apply to your situation.

Chapter 1

Understanding the Taxes You Pay

IN THIS CHAPTER

Knowing your total taxes

Seeing how marginal tax rates work

Understanding the term taxable income

Being aware of the alternative minimum tax

Staying informed about current tax laws

Taxes are probably one of your largest — if not the largest — expenditures. The goal of this chapter is to help you legally and permanently reduce your total taxes. Understanding the tax system is the key to reducing your tax burden — if you don’t, you’ll surely pay more taxes than necessary. Your tax ignorance can lead to mistakes, which can be costly if the IRS and state government catch your underpayment errors. With the proliferation of computerized information and data tracking, discovering mistakes has never been easier.

Focusing on Total Taxes

Instead of focusing on whether you’re going to get a refund when you complete your annual tax return, concentrate on the total taxes you pay.

To find out the total income taxes you pay, you need to get out your federal and state income tax returns. On each of those returns is a line that shows the total tax you owed for the year: If you add up the totals from your federal and state income tax returns, you’ll probably see one of your largest expenses.

Some people feel lucky when they get an income tax refund, but all a refund really indicates is that you overpaid your income taxes during the year. You should have had this money in your own account all along.

If you’re consistently getting big income tax refunds, you need to pay less tax throughout the year. Fill out a W-4 to determine how much you should be paying in taxes throughout the year. You can obtain a W-4 through your employer’s payroll department or from the IRS.

If you’re self-employed, you can obtain Form 1040-ES by calling the IRS at 800-TAX-FORM [800-829-3676] or visiting its website at www.irs.gov. The IRS website also has a helpful withholding calculator at www.irs.gov/individuals/tax-withholding-estimator.

The tax system, like other public policy, is built around incentives to encourage desirable behavior and activity. For example, saving for retirement is considered desirable because it encourages people to prepare for a time in their lives when they may be less able or interested in working so much and when they may have additional healthcare expenses. Therefore, the tax code offers all sorts of tax perks to encourage people to save in retirement accounts.

It’s a free country, and you should make choices that work best for your life and situation. However, keep in mind that the fewer desirable activities you engage in, the more you will generally pay in taxes. If you understand the options, you can choose the ones that meet your needs as you approach different stages of your financial life.

Recognizing the Importance of Your Marginal Tax Rate

When it comes to taxes, not all income is treated equally. This fact is far from self-evident. If you work for an employer and earn a constant salary during the course of a year, a steady and equal amount of federal and state taxes is deducted from each paycheck. Thus, it appears as though all that earned income is being taxed equally.

In reality, however, you pay less tax on your first dollars of earnings and more tax on your last dollars of earnings. For example, if you’re single and your taxable income (see the next section) totals $50,000 during 2024, you pay federal tax at the rate of 10 percent on the first $11,600 of taxable income, 12 percent on income between $11,600 and $47,150, and 22 percent on income from $47,150 up to $100,525.

Table 1-1 gives federal tax rates for singles and married households filing jointly.

TABLE 1-1 2024 Federal Income Tax Brackets and Rates

Federal Income Tax Rate (bracket)

Individual’s Taxable Income

Married Filing Jointly Taxable Income

10%

$0 to $11,600

$0 to $23,200

12%

$11,600 to $47,150

$23,200 to $94,300

22%

$47,150 to $100,525

$94,300 to $201,050

24%

$100,525 to $191,950

$201,050 to $383,900

32%

$191,950 to $243,725

$383,900 to $487,450

35%

$243,725 to $609,350

$487,450 to $731,200

37%

$609,350 or more

$731,200 or more

Your marginal tax rate is the rate of tax you pay on your last, or so-called highest, dollars of income. A single person with taxable income of $50,000 has a federal marginal tax rate of 22 percent. In other words, they effectively pay 22 percent federal tax on their last dollars of income — those dollars in excess of $47,150.

Marginal tax rates are a powerful concept. Your marginal tax rate allows you to quickly calculate the additional taxes you’d have to pay on additional income. Conversely, you can enjoy quantifying the amount of taxes you save by reducing your taxable income, either by decreasing your income or by increasing your deductions.

As you’re probably already painfully aware, you pay not only federal income taxes but also state income taxes — that is, unless you live in one of the handful of states (Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, and Wyoming) that have no state income tax. Note: Some states don’t tax employment income but do tax certain investment income: New Hampshire (dividend and interest income) and Washington (capital gains income).

Your total marginal rate includes your federal and state income tax rates (not to mention local income tax rates in the municipalities that have them).

You can look up your state income tax rate in your current state income tax preparation booklet or on the website for the state agency that collects income tax for your state.

Defining Taxable Income

This book explains strategies for reducing your taxable income. Taxable income is the amount of income on which you actually pay income taxes. The following reasons explain why you don’t pay taxes on your total income:

Not all income is taxable.

For example, you pay federal income tax on the interest you earn on a bank savings account but not on the interest you earn from municipal bonds. Some income, such as from stock dividends and long-term capital gains, is taxed at lower rates.

You get to subtract deductions from your income.

Some deductions are available just for being a living, breathing human being. In 2024, single people get an automatic $14,600 standard deduction, and married couples filing jointly get $29,200. (People over age 65 and those who are blind get a slightly higher deduction.) Other expenses, such as mortgage interest and property taxes, are deductible (subject to limitations) if these so-called itemized deductions exceed the standard deductions. When you contribute to qualified retirement plans, you also effectively get a deduction.

Part 4 discusses ways to reduce small business taxes.

Being Mindful of the Second Tax System: Alternative Minimum Tax

You may find this hard to believe, but a second tax system actually exists (as if the first tax system weren’t already complicated enough). This second system may raise your taxes even higher than they would normally be.

Over the years, as the government grew hungry for more revenue, taxpayers who slashed their taxes by claiming lots of deductions or exclusions from taxable income came under greater scrutiny. So the government created a second tax system — the alternative minimum tax (AMT) — to ensure that those with high deductions or exclusions pay at least a certain percentage of taxes on their incomes. In its early years of existence, the AMT affected less than 1 percent of taxpayers, but that number greatly expanded over the decades until it impacted 5 million taxpayers. The Tax Cuts and Jobs Act, which took effect in 2018, reduced the impact back down to its original intent of just a few hundred thousand higher-income taxpayers. However, those newer rules are scheduled to expire after 2025, at which time the AMT could hit upwards of 7 million taxpayers.

If you have a lot of deductions or exclusions from state income taxes, real-estate taxes, certain types of mortgage interest, and passive investments (for example, rental real estate), you may fall prey to AMT. You may also get tripped up by AMT if you exercise certain types of stock options or if you have a high amount of capital gains relative to your other ordinary income.

AMT restricts you from claiming certain deductions and requires you to add back in income that is normally tax-free (like certain municipal-bond interest). So you have to figure your tax under the AMT system and under the other system and then pay whichever amount is higher.

BEYOND APRIL 15: WHAT YOU DON’T KNOW CAN COST YOU

Every spring, more than 100 million tax returns (and several million extension requests) are filed with the IRS. The byproduct of this effort is guaranteed employment for the nation’s more than 1 million accountants and auditors and 2 million bookkeeping and accounting clerks (not to mention more than a few tax-book authors and their editors). Accounting firms rake in tens of billions of dollars annually, helping bewildered and desperately confused taxpayers figure out all those tax laws. So that you can feel okay about this situation, keep in mind that at least some of the money you pay in income taxes actually winds up in the government coffers for some useful purposes.

Given all the hours that you work each year just to pay your taxes and the time you spend actually completing the dreaded return, on April 16, you may feel like ignoring the whole tax topic until next year. Such avoidance, however, is a costly mistake. You can end up increasing your tax burden and reducing your ability to trim the taxes you owe, and if you file late, you will be subjected to late filing fees with accruing interest.

During the tax year, you can take steps to ensure not only that you’re in compliance with the ever-changing tax laws, but also that you’re minimizing your tax burden. If your income — like that of nearly everyone I know — is limited, you need to understand the tax code to make it work for you and help you accomplish your financial goals.

Noting the Forever Changing Tax Laws

Since tax law changes are passed by Congress, they change as the makeup of Congress changes. The most recent major piece of tax legislation was the Tax Cuts and Jobs Act of 2017, which took effect for tax years 2018 and beyond. There have been some smaller pieces of legislation since, addressing retirement accounts and savings and the COVID-19 pandemic. This section provides the highlights for this more recent legislation and associated tax law changes.

The Tax Cuts and Jobs Act of 2017

For most individuals, the biggest change from the Tax Cuts and Jobs Act bill was the lowering of tax rates. The lower tax brackets were lowered by three full percentage points (for example, from 15 percent down to 12 percent, from 25 percent down to 22 percent), and the next income bracket up from that was cut four full percentage points from 28 percent down to 24 percent, which produced substantial tax savings for lower- and moderate-income earners. The highest income earning taxpayers saw smaller reductions in their tax brackets.

According to Brian Riedl, a senior fellow at the Manhattan Institute, a greater share of the individual income tax benefits from this bill went to lower- and moderate-income earners.

Here are some of the other major changes in this tax bill:

Increased standard deduction and eliminated personal exemption:

Proponents of the bill liked to talk about how the standard deduction nearly doubled. This amount is deducted from your income before arriving at your taxable income, so a larger standard deduction reduces your taxable income and tax bill. However, Congress also eliminated personal exemptions, which offset much of this change. Ultimately, though, far more taxpayers can simply claim the standard deduction, which is a time-saver when it comes to completing the annual federal 1040 tax form.

Increased child tax credit:

The child tax credit was doubled by this legislation, and up to 70 percent of that credit was made refundable for taxpayers not otherwise owing federal income tax. Also, the incomes at which this credit starts phasing out was more than tripled for married couples and more than doubled for non-married filers.

State and local taxes deduction capped at $10,000:

This also includes property taxes on your home, and for homeowners in high cost-of-living areas with high state income taxes (for example, metro areas such as San Francisco, Los Angeles, New York, and Washington D.C.), this cap poses a modest or even significant negative change. Because these taxes are itemized deductions, only being able to take up to $10,000 (previously unlimited) caused some taxpayers to no longer be able to itemize. Also, by reducing the tax benefits of home ownership, this change effectively raises the cost of home ownership, especially in high-cost and highly taxed areas.

Mortgage-interest deduction for both primary and second homes capped at $750,000 borrowed:

This represents a modest reduction from the previous $1 million limit on mortgage indebtedness deductibility.

The Tax Cuts and Jobs Act also brought some long overdue corporate tax reform. For too long, the United States had way too high a corporate tax rate, which caused increasing numbers of companies to choose to do less business in the United States.

The SECURE ACTs of 2019 & 2022

Retirement accounts and retirement savings rules were ripe for revisions and improvement. Some of those happened with the SECURE (Setting Every Community Up for Retirement Enhancement) Act of 2019. Of course, Congress couldn’t leave well enough alone. So another bill — the SECURE Act 2.0 of 2022 — was passed to make yet more changes to retirement accounts. Here are the highlights of these two bills:

Small-business owners are eligible for up to $5,000 in tax credits when starting a retirement plan.

This credit applies to new 401(k), profit sharing, SEP, and SIMPLE plans for small employers (up to 100 employees).

More workers can participate in company 401(k) plans.

Previously, employees had to work at least 1,000 hours per year to take part in a company’s 401(k) plan. Now, workers who achieve at least 500 hours over three consecutive years may participate. Effective in 2025, employees must be eligible to participate in their employer’s qualified retirement plans after two years of service.

You can withdraw up to $5,000 per parent penalty-free from your retirement plan for the birth or adoption of a child.

This new provision waives the normal 10 percent early withdrawal penalty and allows you to repay the withdrawn money as a rollover contribution.

529 funds can be used to pay down student loans.

You can pay down up to $10,000 in student loans and pay for qualifying apprenticeship programs.

Employer matching of student loan repayments permitted.

Beginning in 2024, employers can elect to match student loan repayments in the form of retirement account contributions.

Automatic employee enrollment in company 401(k) and 403(b) plans.

Beginning with new 401(k) and 403(b) plans in 2025, companies must automatically enroll eligible employees.

Increase in retirement plan contribution limits for older workers.

As of 2024, workers aged 50 and older are able to contribute $7,500 more per year (increased annually with inflation) than younger workers to most retirement plans. Beginning in 2025, the contribution limits for those aged 60 to 63 increases so that that age group may contribute up to $10,000 more per year (increasing annually with inflation) than younger workers in most retirement plans and $5,000 more annually for SIMPLE plans.

Required minimum distributions (RMDs) from retirement accounts begin at age 72, not 70½.

Effective in 2023, the RMD increased to 73, and then goes to age 75 in 2033. This gives you more options and flexibility, but delaying required distributions that are based upon your life expectancy may or may not be in your best long-term interests.

You can make traditional IRA contributions past age 70½ so long as you continue earning employment income.

This brings the contribution rules for these accounts into alignment with those for Roth IRAs and 401(k)s.

Inherited retirement accounts must now be tapped and emptied through distributions generally within a decade.

Before when folks inherited a retirement account, the inheritor could stretch their distributions and associated tax payments out over their life expectancy. For retirement accounts now inherited from original owners who have passed away in 2020 or later years, most beneficiaries must complete withdrawals from the account within ten years of the death of the account holder. There are some exceptions to this ten-year rule for retirement accounts left to a surviving spouse, a minor child, a disabled or chronically ill beneficiary, and beneficiaries who are less than ten years younger than the original retirement account owner.

Possible upcoming changes

Congress continually tinkers with our nation’s tax laws. Bigger changes tend to occur when the same party controls both chambers of congress as well as the presidency. As this book goes to press in 2024, Americans have been through a lengthy period where there has been lots of talk of tax increases by the Democrats, the party currently in control of the Senate and the presidency, but that has largely been blocked to date due to their super-slim majority in the Senate and by the Republican controlled House of Representatives.

With the 2024 elections on the horizon, history suggests that the most likely outcome for those elections will be continued divided government, which likely will mean more gridlock and less likelihood for tax increases or tax changes in general.

Chapter 2

Trimming Your Taxes

IN THIS CHAPTER

Lowering your income taxes

Claiming deductions

Reducing taxes on investment income

Being aware of education tax breaks

Seeking help from professionals and other tax resources

Knowing what to do if you receive an audit request letter

The tax system is built around incentives to encourage desirable behavior and activity. Home ownership, for example, is considered good because it encourages people to take more responsibility for maintaining properties and neighborhoods. Therefore, the government offers numerous tax benefits, referred to as allowable deductions, to encourage people to own homes (see Chapter 13). But if you don’t understand these tax benefits, you probably don’t know how to take full advantage of them, either.

Don’t feel dumb when it comes to understanding the tax system. You’re not the problem — the complexity of the income tax system is. Making sense of the tax jungle is more daunting than hacking your way out of a triple-canopy rainforest with a dinner knife. That’s why, throughout this book, I help you understand the tax system, and I promise not to make you read the actual tax laws.

You should be able to keep much more of your money by applying the tax-reducing strategies I present in this book. This chapter summarizes those strategies, and later parts delve into the nitty-gritty for each.

Reducing Taxes on Work Income

When you earn money from work, you’re supposed to pay income tax on that income. Some people avoid taxes by illegal means, such as by not reporting work income (which isn’t really possible if you’re getting a regular paycheck from an employer), but 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. This section focuses on the legal ways to reduce your income taxes on work-related income.

Self-employed workers and business owners also must pay income tax, but their considerations are subject to some unique rules and can be a bit more complex. Part 4 covers these considerations and more.

Contributing to retirement investment plans

A retirement investment plan is one of the few relatively painless and authorized ways to reduce your taxable employment income. Besides reducing your taxes, retirement plans help you build up a nest egg so you don’t have to work for the rest of your life.

You can exclude money from your taxable income by tucking it away in employer-based retirement plans, such as 401(k) or 403(b) accounts, or self-employed retirement plans, such as SEP-IRAs. If your combined federal and state marginal tax rate is, say, 33 percent and you contribute $1,000 to one of these plans, you reduce your federal and state taxes by $330. Do you like the sound of that? How about this: Contribute another $1,000, and your taxes drop another $330 (as long as you’re still in the same marginal tax rate). And when your money is inside a retirement account, it can compound and grow without taxation.

Many people miss this great opportunity to reduce their taxes because they spend all (or too much) of their current employment income and, therefore, have nothing (or little) left to put into a retirement account. If you’re in this predicament, you first need to reduce your spending before you can contribute money to a retirement plan.

If your employer doesn’t offer the option of saving money through a retirement plan, lobby the benefits and human resources departments. If they resist, you may want to add this to your list of reasons for considering another employer. Many employers offer this valuable benefit, but some don’t. Some company decision-makers either don’t understand the value of these accounts or feel that they’re too costly to set up and administer.

If your employer doesn’t offer a retirement savings plan, individual retirement account (IRA) contributions may or may not be tax-deductible, depending on your circumstances. You should first maximize contributions to the previously mentioned tax-deductible accounts. Chapter 4 can help you determine whether you should contribute to an IRA, what type you should contribute to, and whether your IRA contributions are tax-deductible.

Lower- and moderate-income earners can gain a federal tax credit known as the “Saver’s Credit.” Married couples filing jointly with adjusted gross incomes (AGIs) of less than $76,500 and single taxpayers with an AGI of less than $38,250 can earn a tax credit (claimed on Form 8880) for retirement account contributions. Unlike a deduction, a tax credit directly reduces your tax bill by the amount of the credit. This credit, which is detailed in Table 2-1, is a percentage of the first $2,000 contributed (or $4,000 on a joint return). The credit is not available to those under the age of 18, full-time students, or people who are claimed as dependents on someone else’s tax return.

TABLE 2-1 Special Tax Credit for Retirement Plan Contributions

Singles Adjusted Gross Income

Married-Filing-Jointly Adjusted Gross Income

Tax Credit for Retirement Account Contributions

$0–$23,000

$0–$46,000

50%

$23,000–$25,000

$46,000–$50,000

20%

$25,000–$38,250

$50,000–$76,500

10%

Using health savings accounts

You can reduce your taxable income and sock away money for future healthcare expenses by taking advantage of a health savings account (HSA). In fact, HSAs can offer superior tax savings versus retirement accounts because in addition to providing upfront tax breaks on contributions and tax-free accumulation of investment earnings, you can also withdraw money from HSAs tax-free so long as the money is used for healthcare costs. No other retirement accounts offer this triple tax-free benefit.

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 receive their income.

For example, suppose your employer tells you in late December that you’re eligible for a bonus. You’re offered the option to receive your bonus in either December or January. If you’re pretty certain that you’ll be in a higher tax bracket next year, you should choose to receive your bonus in December.

Or, suppose you run your own business and you think that you’ll be in a lower tax bracket next year. Perhaps you plan to take time off to be with a newborn or take an extended trip. You can send out some invoices later in the year so your customers won’t pay you until January, which falls in the next tax year.

Increasing Your Deductions

Deductions are amounts you subtract from your adjusted gross income before calculating the tax you owe. To make things more complicated, the IRS gives you two methods for determining your total deductions. The good news is that you get to pick the method that leads to greater deductions — and hence, lower taxes. This section explains your options.

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. With the tax reform bill implemented in 2018, more people are better off taking the standard deduction. And that is in fact what has been happening with nearly nine in ten taxpayers now taking the standard deduction (down from about two-thirds previously).

Single folks qualify for a $14,600 standard deduction, and married couples filing jointly get a $29,200 standard deduction in 2024. If you’re 65 or older, or blind, you get a slightly higher standard deduction.

Itemizing your deductions on your tax return is the other method for determining your allowable deductions. This method is definitely more of a hassle, but if you can tally up more than the standard amounts noted in the preceding paragraph, itemizing will save you money. Use Schedule A of IRS Form 1040 to tally your itemized deductions.

Even if you take the standard deduction, take the time to peruse all the line items on Schedule A to familiarize yourself with the many legal itemized deductions. Figure out what’s possible to deduct so you can make more-informed financial decisions year-round.

Purchasing real estate

When you buy a home, you can claim two big ongoing expenses of homeownership as deductions on Schedule A: your property taxes and the interest on your mortgage. You’re allowed to claim mortgage interest deductions for a primary residence (where you actually live) and on a second home for mortgage debt totaling up to $750,000, which is down from the previous limit of $1 million (and a home equity loan of up to $100,000). You may be grandfathered under the higher $1 million limit if your mortgage was taken out before December 16, 2017, or if you had a home under contract by that date and closed on that purchase by April 1, 2018.

Before 2018, there was no limit on property tax deductions on Form 1040, Schedule A. Now, property taxes (combined with state and local income tax payments) are limited to a maximum $10,000 annual deduction.

To buy real estate, you need to first collect a down payment, which requires maintaining a lid on your spending. Check out Part 5 for more on investing in real estate.

Trading consumer debt for mortgage debt

When you own real estate, you haven’t borrowed the maximum, and you’ve 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. You can usually borrow at a lower interest rate for a mortgage and get a tax deduction as a bonus, which lowers the effective borrowing cost further. Consumer debt, such as that on auto loans and credit cards, isn’t tax-deductible.

This strategy involves some danger. Borrowing against the equity in your home can be an addictive habit. I’ve seen cases where people run up significant consumer debt three or four times and then refinance their home the same number of times over the years to bail themselves out.

An appreciating home creates the illusion that excess spending isn’t really costing you. But debt is debt, and all borrowed money ultimately has to be repaid (unless you file bankruptcy). In the long run, you wind up with greater mortgage debt, and paying it off takes a bigger bite out of your monthly income. Refinancing and establishing home equity lines cost you more in terms of loan application fees and other charges (points, appraisals, credit reports, and so on).

At a minimum, the continued expansion of your mortgage debt handicaps your ability to work toward other financial goals. In the worst case, easy access to borrowing encourages bad spending habits that can lead to bankruptcy or foreclosure on your debt-ridden home.

Contributing to charities

You can deduct contributions to charities if you itemize your deductions on Form 1040, Schedule A. Consider the following possibilities:

Most people know that when they write a check for $50 to their favorite church or college, they can deduct it.

Note:

Make sure that you get a receipt for contributions of $250 or more.

Many taxpayers overlook the fact that you can deduct expenses for work you do with charitable organizations. For example, when you go to a soup kitchen to help prepare and serve meals, you can deduct some of your transportation costs. Keep track of your driving mileage and other commuting expenses.

You can deduct the fair market value (which can be determined by looking at the price of similar merchandise in thrift stores) of donations of clothing, household appliances, furniture, and other goods to charities. (Some charities will drive to your home to pick up the stuff.) Find out whether organizations such as the Salvation Army, Goodwill, or others are interested in your donation. Just make sure that you keep some documentation — write up an itemized list and get it signed by the charity. Take pictures of your more valuable donations.

You can even donate securities and other investments to charity. In fact, donating an appreciated investment gives you a tax deduction for the full market value of the investment and eliminates your need to pay tax on the (unrealized) profit.

Remembering auto registration fees and state insurance

If you 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 license your car, you can itemize a portion of the expenditure as a deduction (on Schedule A, “State and Local Personal Property Taxes”). 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. (Some states detail on the invoice what portion of the fee is tax-deductible.) There’s a $10,000 annual federal income tax deduction limit on all deductible state and local taxes combined with property tax payments on your home.

Several states have state disability insurance funds. If you pay into these funds (check your W-2), you can deduct your payments as state and local income taxes on Schedule A. You may also claim a deduction on this line for payments you make into your state’s unemployment compensation fund.

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. If you buy a computer or office furniture, you can deduct those expenses. (Sometimes they need to be gradually deducted, or depreciated, over time.) Salaries for your employees, office supplies, rent or mortgage interest for your office space, and phone/communications expenses are also generally deductible.

Many self-employed folks don’t take all the deductions they’re eligible for. In some cases, people simply aren’t aware of the wonderful world of deductions. Others are worried that large deductions will increase the risk of an audit. Spend some time finding out more about tax deductions; you’ll be convinced that taking full advantage of your eligible deductions makes sense and saves you money.

Part 4 discusses small business deductions and other considerations for small business owners.

Lowering Investment Income Taxes

The distributions and profits on investments that you hold outside of tax-sheltered retirement accounts are exposed to taxation. 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. The good news: You can take action to reduce the taxes in those accounts.

When you invest, you can invest in a way that fits your tax situation. This strategy can make you happier and wealthier come tax time. For example, you can choose tax-friendly investments (such as tax-free bonds) that reduce your tax bill and increase your after-tax investment returns.

Part 3 explains how investment income is taxed. The chapters in that part help you consider an investment strategy that works for your situation.

Enlisting Education Tax Breaks

The U.S. tax laws include numerous tax breaks for education-related expenditures. Here are the important tax-reduction opportunities you should know about for yourself and your kids if you have them:

Tax deductions for college expenses:

You may take up to a $2,500 tax deduction on IRS Form 1040 for college costs as long as your modified adjusted gross income (AGI) is less than $80,000 for single taxpayers and less than $165,000 for married couples filing jointly. (

Note:

You may take a partial tax deduction if your AGI is between $80,000 and $95,000 for single taxpayers and between $165,000 and $195,000 for married couples filing jointly.)

Tax-free investment earnings in special accounts:

Money invested in Section 529 plans is sheltered from taxation and is not taxed upon withdrawal as long as the money is used to pay for eligible education expenses. 529 plans allow you to sock away more than $200,000. However, funding such accounts may harm your kid’s qualifications for financial aid.

American Opportunity tax credit:

The American Opportunity credit provides tax relief to low- and moderate-income earners facing education costs. The full credit (up to $2,500 per student) is available to individuals whose modified adjusted gross income is $80,000 or less, or $160,000 or less for married couples filing jointly. The credit is phased out for single taxpayers above $90,000 and married couples filing jointly above $180,000. The credit can be claimed for expenses for the first four years of postsecondary education. You may be able to claim an American Opportunity tax credit in the same year in which you receive a distribution from either an ESA or 529, but you can’t use expenses paid with a distribution from either an ESA or 529 as the basis for the American Opportunity credit.

Lifetime Learning tax credit:

The Lifetime Learning credit may be up to 20 percent of the first $10,000 of qualified educational expenses — up to $2,000 per taxpayer. For parents filing tax returns, only this credit or the American Opportunity tax credit may be claimed for each child per tax year. Single taxpayers’ phaseout for being able to take this credit is at modified adjusted gross incomes (MAGIs) of $80,000 to $90,000. Other taxpayers’ phaseout is from $160,000 to $180,000.

Getting Help from Tax Resources

There are all sorts of ways to prepare your tax return. 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 steps 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.

Obtaining IRS assistance

If you have a simple, straightforward tax return, filing it on your own using only the IRS instructions is likely fine. This approach is as cheap as you can get. The main costs are time, patience, photocopying expenses (you should always keep a copy for your files), and postage for mailing the completed tax return (unless you’re filing electronically).

IRS publications don’t have Tip or Warning icons. And the IRS has been known to give wrong information from time to time. When you call the IRS with a question, be sure to take notes about your conversation to protect yourself in the event of an audit. Date your notes and include the name and identification number of the tax employee you talked to, the questions you asked, and the employee’s responses. File your notes in a folder with a copy of your completed return.

In addition to the IRS’s standard tax-return preparation instructions, the IRS offers some free (actually, paid for with your tax dollars) and sometimes-useful booklets. Publication 17, Your Federal Income Tax, is designed for individual tax-return preparation. Publication 334, Tax Guide for Small Businesses, is for (you guessed it) small-business tax-return preparation (particularly those small business owners who use Form 1040, Schedule C). These publications are more comprehensive than the basic IRS instructions. Call 800-829-3676 to request these booklets or visit the IRS website at www.irs.gov.

Consulting preparation and advice guides

Books about tax preparation and tax planning that highlight common problem areas and are written in clear, simple English are invaluable. They supplement the official instructions not only by helping you complete your return correctly but also by showing you how to save as much money as possible.

Check out the latest edition of Taxes For Dummies, which I co-authored, and my Small Business Taxes For Dummies, both published by Wiley.

Using software and websites

If you have access to a computer, good tax-preparation software can be helpful. TurboTax, H&R Block Tax Software, and TaxSlayer 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.

For you web surfers, the Internal Revenue Service website (www.irs.gov) is among the better internet tax sites, believe it or not.

Hiring professional help

Competent tax preparers and advisors 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 be unaware of sound ways to reduce your tax bill.

Tax preparers and advisors come with varying backgrounds, training, and credentials. The four main types of tax practitioners are preparers, enrolled agents (EAs), certified public accountants (CPAs), and tax attorneys. The more training and specialization a tax practitioner has (and the more affluent their clients), the higher their hourly fee usually is. Fees and competence vary greatly. If you hire a tax advisor and you’re not sure of the quality of the work performed or the soundness of the advice, try getting a second opinion.

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.

Preparers are appealing because they’re relatively inexpensive — they can do most basic returns for around $100 or so. The drawback of using a preparer is that you may hire someone who doesn’t know much more than you do.

Preparers make the most sense for folks who have relatively simple financial lives, who are budget-minded, and who hate doing their own taxes. If you’re not good about hanging on to receipts or you don’t want to keep your own files with background details about your taxes, you should definitely shop around for a tax preparer who’s committed to the business. You may need all that stuff someday for an audit, and many tax preparers keep and organize their clients’ documentation rather than return everything each year. Also, going with a firm that’s open year-round may be a safer option (some small shops are open only during tax season) in case tax questions or problems arise.

Enrolled agents (EAs)

A person must pass IRS scrutiny in order to be called an enrolled agent. This license allows the agent to represent you before the IRS in the event of an audit. Continuing education is also required; an EA’s training is generally longer and more sophisticated than that of a typical preparer.

Enrolled agents’ fees tend to fall between those of a preparer and a CPA (see the next section). Returns that require a few of the more common schedules (such as Schedule A for deductions and Schedule D for capital gains and losses) shouldn’t cost more than a few hundred dollars to prepare.

EAs are best for people who have moderately complex returns and don’t necessarily need complicated tax-planning advice throughout the year (although some EAs provide this service as well). You can get names and telephone numbers of EAs in your area by contacting the National Association of Enrolled Agents (NAEA). You can call the NAEA at 202-822-6232 or visit its website at www.naea.org.

Certified public accountants (CPAs)

Certified public accountants 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.

CPA fees vary tremendously. Most charge $150+ per hour, but CPAs at large companies and in high-cost-of-living areas tend to charge somewhat more.