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- Herausgeber: John Wiley & Sons
- Kategorie: Ratgeber
- Sprache: Englisch
Cut your tax bill down to size with year-round tips and tricks Taxes For Dummies is the antidote to the annual headache that is the U.S. tax system. This book paves the way for you to file a return that maximizes all the deductions and credits available to you. It also provides insight on making smart financial decisions that help minimize your tax burden. Need to correct or revise a return? You'll find all the information you need to do it right this time. And, of course the A-word is covered--learn what to do if the IRS shows up on your doorstep to audit your return. This new edition provides updates on the latest changes to the U.S. tax system, so you can sail through this year's tax season, headache free. * Prepare your yearly tax return with confidence * Apply sound strategies to reduce your tax bill * Discover year-round ways to keep more of your earnings * Create a tax-savvy financial plan, with or without the help of an advisor With Taxes For Dummies, anyone seeking a deeper understanding of the U.S. tax filing system can learn what they need to save money and manage taxes throughout the year.
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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: Getting Ready to File
Chapter 1: Understanding the U.S. Tax System
Figuring Out the U.S. Tax System
Understanding Your Income Tax Rates
Noting the Forever Changing Tax Laws
Chapter 2: Tax Return Preparation Options and Tools
Going It Alone: Preparing Your Own Return
Taking Advantage of IRS Publications
Perusing Tax-Preparation and Advice Guides
Using Software
Accessing Internet Tax Resources
Hiring Help
Finding Tax Preparers and Advisors
Chapter 3: Getting and Staying Organized
Maintaining the Burden of Proof
Keeping Good Records
Reconstructing Missing Tax Records
Understanding the Cohan Rule
Chapter 4: What Kind of Taxpayer Are You?
What Rendition of 1040 Shall We Play?
Choosing a Filing Status
Filing for Children and Other Dependents
Defining Who Is a Qualifying Child
Filing a Return for a Deceased Taxpayer
Must I File?
A Final Bit of Advice
Part 2: Tackling the Main Forms
Chapter 5: All The Form 1040s: Income Stuff
Starting at the Very Beginning: The Top of 1040
Lines 1–9: Income
Chapter 6: Form 1040, Schedule 1, Part I: Additional Income
Schedule 1, Part I, Line 1: Taxable Refunds, Credits, or Offsets
Schedule 1, Part I, Lines 2a and 2b: Alimony Received (by You)
Schedule 1, Part I, Line 3: Business Income (or Loss)
Schedule 1, Part I, Line 4: Other Gains (or Losses)
Schedule 1, Part I, Line 5: Rental Real Estate, Partnerships, and More
Schedule 1, Part I, Line 6: Farm Income (or Loss)
Schedule 1, Part I, Line 7: Unemployment Compensation
Schedule 1, Part I, Line 8: Other Income
Schedule 1, Part I, Line 9: Total Other Income
Schedule 1, Part I, Line 10: Combine Lines 1 through 7 and 9
Chapter 7: Form 1040, Schedule 1, Part II: Adjustments to Income Stuff
Figuring Out Your Adjusted Gross Income (AGI)
Form 1040, Line 11: Adjusted Gross Income
Chapter 8: Form 1040, Schedule 2: Additional Taxes
Schedule 2, Part I: Tax
Schedule 2, Part II: Other Taxes
Bringing Us to Line 21
Chapter 9: Form 1040, Schedule 3: Adding Up Your Credits and Payments
Schedule 3, Part I: Nonrefundable Credits
Schedule 3, Part II: Other Payments and Refundable Credits
Chapter 10: Finishing Up the 1040
Arriving at Taxable Income
Calculating Your Tax Liability
Calculating Your Payments and Refundable Credits
Refund or Amount You Owe
Finishing Up
Part 3: Filling Out Schedules and Other Forms
Chapter 11: Itemized Deductions: Schedule A
Claiming the Standard Deduction
Locating Your Itemized Deductions
Lines 1–4: Medical and Dental Costs
Lines 5–7: Taxes You Paid
Lines 8–10: Interest You Paid
Lines 11–14: Gifts to Charity
Line 15: Casualty and Theft Losses (Form 4684)
Line 16: Other Itemized Deductions
Line 17: Total Itemized Deductions
Line 18: Check the Box
Chapter 12: Interest and Dividend Income: Form 1040, Schedule B
Part I, Lines 1–4: Interest Income
Part II, Lines 5–6: Dividend Income
Part III, Lines 7–8: Foreign Accounts and Trusts
Chapter 13: Business Tax Schedules: C and F
Schedule C
Giving Basic Information (A–E)
Accounting Method Stuff (Boxes F–H)
Marking Information Returns (Boxes I and J)
Part I, Lines 1–7: Income
Part II, Lines 8–27b: Expenses
Operating Loss
Schedule F: Profit or Loss from Farming
Chapter 14: Capital Gains and Losses: Schedule D and Form 8949
Claiming Capital Sales: Collectibles and Real Estate
Noting the Different Parts of Schedule D
Form 8949: Sales and Other Dispositions of Capital Assets
Calculating Your Adjusted Basis
Part I, Lines 1–7: Short-Term Capital Gains and Losses
Part II, Lines 8–15: Long-Term Capital Gains and Losses
Part III, Lines 16–22: Summary of Parts I and II
Using Schedule D for Home Sales
Using Form 8949 and Schedule D for Other Stock Matters
Reporting Nonbusiness Bad Debts
Checking On Cryptocurrency
Chapter 15: Supplemental Income and Loss: Schedule E
Part I: Income or Loss from Rental Real Estate and Royalties
Part II: Income or Loss from Partnerships and S Corporations
Part III: Income or Loss from Estates and Trusts
Part IV: Income or Loss from Real Estate Mortgage Investment Conduits
Part V: Summary
Chapter 16: Giving Credits Where Credits Are Due
Child- and Dependent-Care Expenses: Form 2441 (1040)
Credit for the Elderly or the Disabled: Schedule R (1040)
Education Credits (Form 8863)
Child Tax Credit and Credit for Other Dependents
Retirement Savings Contributions Credit (Form 8880)
Residential Energy Credits (Form 5695)
Adoption Credit (Form 8839)
Motor Vehicle Credits (Form 8936)
Earned Income Credit (EIC)
Chapter 17: Other Schedules and Forms to File
Estimated Tax for Individuals (Form 1040-ES)
Moving Expenses (Form 3903)
Nondeductible IRAs (Form 8606)
Forms 8615 and 8814, the Kiddie Tax
Form 8829, Expenses for Business Use of Your Home
Form W-4, Employee Withholding
Household Employment Taxes: Schedule H
Schedule SE: Self-Employment Tax Form
Part 4: Audits and Errors: Dealing with the IRS
Chapter 18: Dreaded Envelopes: IRS Notices, Assessments, and Audits
Understanding the IRS Notice Process
Assessing Assessment Notices
Requesting a Collection Due Process Hearing
Handling Non-Assessment Notices
Understanding What You Must Know about Audits
Surviving the Four Types of Audits
Questioning Repetitive Audits
Getting Ready for an Audit
Winning Your Audit
Understanding the Statute of Limitations on Audits
Chapter 19: Fixing Mistakes the IRS Makes
Seeing the Types of Mistakes the IRS Makes
Corresponding with the IRS: The Basics
Sending a Simple Response to a Balance Due Notice
Sending Generic Responses to Generic Notices
Getting Attention When the IRS Appears to Be Ignoring You
Finding Your Refund When It Doesn’t Find You
Chapter 20: Fixing Your Own Mistakes
Amending a Return
Solving When You Can’t Pay Your Taxes
Abating a Penalty
Abating Interest
Protecting Yourself with Innocent Spouse Relief
The Taxpayer Bill of Rights: In the Beginning
The Taxpayer Bill of Rights: Parts 2 and 3
Part 5: Year-Round Tax Planning
Chapter 21: Tax-Wise Personal Finance Decisions
Including Taxes in Your Financial Planning
Taxing Mistakes
Comprehending the Causes of Bad Tax Decisions
Chapter 22: Trimming Taxes with Retirement Accounts
Identifying Retirement Account Benefits
Naming the Types of Retirement Accounts
Taxing Retirement Account Decisions
Chapter 23: Small-Business Tax Planning
Organizing Your Business Accounting
Minimizing Your Small-Business Taxes
Deciding to Incorporate or Not to Incorporate
Investing in Someone Else’s Business
Buying or Selling a Business
Chapter 24: Your Investments and Taxes
Tapping into Tax-Reducing Investment Techniques
Uncovering Tax-Favored Investments to Avoid
Analyzing Annuities
Selling Decisions
Chapter 25: Real Estate and Taxes
Surveying Real Estate Tax Breaks
Purchasing Your Humble Home
Making Tax-Wise Mortgage Decisions
Selling Your House
Investing in Real Estate
Chapter 26: Children and Taxes
Bringing Up Baby
Navigating Education Tax Breaks and Pitfalls
Being Aware of Taxes on Your Kids’ Investments
Chapter 27: Estate Planning
Figuring Whether You May Owe Estate Taxes
Reducing Expected Estate Taxes
Part 6: The Part of Tens
Chapter 28: Ten Tips for Reducing Your Chances of Being Audited
Double-Check Your Return for Accuracy
Declare All Your Income
Don’t Itemize
Earn a Moderate Amount of Money
Don’t Cheat and Put Down Your Protest Sign
Stay Away from Back-Street Refund Mills
Be Careful with Hobby Losses
Don’t Be a Nonfiler
Don’t Cut Corners if You’re Self-Employed
Carry a Rabbit’s Foot
Chapter 29: 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 30: 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
Chapter 31: Ten Interview Questions for Tax Advisors
What Tax Services Do You Offer?
Do You Have Areas that You Focus On?
What Other Services Do You Offer?
Who Will Prepare My Return?
How Aggressive or Conservative Are You Regarding Tax Strategies?
What’s Your Experience with Audits?
How Does Your Fee Structure Work?
What Qualifies You to Be a Tax Advisor?
Do You Carry Liability Insurance?
Can You Provide References of Clients Similar to Me?
Appendix: Glossary
A
B
C
D
E
F
G
H
I
J
K
L
M
N
O
P
Q
R
S
T
U
W
Z
Index
About the Authors
Connect with Dummies
End User License Agreement
List of Tables
Chapter 1
Table 1-1 2023 Federal Income Tax Brackets and Rates
Chapter 4
Table 4-1 Filing Jointly versus Separately: A Sample Couple
Table 4-2 How to Compute the Cost of Maintaining a Home
Table 4-3 When You Must File
Chapter 6
Table 6-1 State and Local Income Tax Refund Worksheet
Chapter 7
Table 7-1 HR10 and SEP Conversion Table
Table 7-2 Who Can Make a Deductible Contribution in 2023?
Chapter 8
Table 8-1 Repayment Limitation for Premium Tax Credit
Chapter 10
Table 10-1 Tax Rate Schedules for 2023
Table 10-2 Qualified Dividends and Capital Gain Tax Worksheet — Line 16
Chapter 11
Table 11-1 Standard Deduction Chart for People Age 65 or Older or Blind in 2023
Table 11-2 Standard Deduction Worksheet for Dependents in 2023
Chapter 13
Table 13-1 Useful Life
Table 13-2 MACRS (Modified Accelerated Cost Recovery System): 5-Year Property
Table 13-3 MACRS: 7-Year Property
Table 13-4 MACRS: 15-Year Property
Table 13-5 Residential Rental Property (27½-Year)
Table 13-6 Commercial Property (31½ Years and 39 Years)
Table 13-7 Depreciation Deductions for New and Used Cars Subject to the Luxury C...
Table 13-8 MACRS Straight-Line Method for Auto Depreciation Using the Half-Year ...
Table 13-9 2021 Annual Depreciation Ceiling for Cars Put into Service Prior to 2...
Table 13-10 Inclusion Amounts
Chapter 16
Table 16-1 Earned Income Credit Phase-Outs
Chapter 17
Table 17-1 39-Year Depreciation Schedule for Business Use of Home (%)
Chapter 22
Table 22-1 2023 Tax Credit for the First $2,000 in Retirement Plan Contributions
Chapter 24
Table 24-1 Federal Tax Rate (2023) on Stock Dividends and Long-Term Capital Gain...
List of Illustrations
Chapter 1
FIGURE 1-1: Income state tax rates for each state.
Chapter 5
FIGURE 5-1: The biographical section of Form 1040 tells the IRS who you are and...
FIGURE 5-2: The income section of Form 1040 lists how much you made in 2023.
FIGURE 5-3: Form W-2 shows how much you earned and various taxes you paid.
FIGURE 5-4: Form 1099-R tells you about distributions made from your retirement...
Chapter 6
FIGURE 6-1: Schedule 1, Part I, Additional Income.
FIGURE 6-2: Form 1099-G shows unemployment compensation benefits received in bo...
Chapter 7
FIGURE 7-1: Form 1040, Schedule 1, Part II may lower your taxes.
FIGURE 7-2: Limit on housing expenses worksheet.
Chapter 8
FIGURE 8-1: Form 1040, Schedule 2, Part I, includes two different additional in...
FIGURE 8-2: Form 1040, Schedule 2, Part II, includes all the additional varieti...
Chapter 9
FIGURE 9-1: Form 1040, Schedule 3, Part I, Nonrefundable Credits
FIGURE 9-2: Form 1040, Schedule 3, Part II: Other payments and refundable credi...
Chapter 10
FIGURE 10-1: Arriving at taxable income on Form 1040.
FIGURE 10-2: Pulling together all the pieces of your tax liability.
FIGURE 10-3: Calculating your total federal income tax.
FIGURE 10-4: The rest of the Form 1040. Fill it in and you’re done.
FIGURE 10-5: A sample check.
Chapter 11
FIGURE 11-1: Use Schedule A to determine the itemized deductions that you can c...
FIGURE 11-2: Use this decision tree to determine how much of your initial loan ...
Chapter 12
FIGURE 12-1: Report your interest and dividend income on Schedule B.
FIGURE 12-2: You receive Form 1099-INT from institutions that pay you taxable i...
FIGURE 12-3: Form 1099-DIV shows you the dividends you reaped in 2021.
Chapter 13
FIGURE 13-1: Schedule C, Page 1.
FIGURE 13-2: Schedule F, Profit or Loss From Farming.
Chapter 14
FIGURE 14-1: Schedule D, Page 1.
FIGURE 14-2: Form 8949, Page 1.
Chapter 15
FIGURE 15-1: Schedule E, Page 1.
FIGURE 15-2: Schedule E, Page 2.
Chapter 19
FIGURE 19-1: Here’s how to compose a “Dear IRS” letter that gets right to the p...
FIGURE 19-2: Use this battle-proven generic letter to respond to an IRS notice....
Chapter 20
FIGURE 20-1: A sample reasonable cause letter.
FIGURE 20-2: A sample letter to abate interest.
Chapter 27
FIGURE 27-1: State estate and inheritance taxes.
Guide
Cover
Table of Contents
Title Page
Copyright
Begin Reading
Appendix: Glossary
Index
About the Authors
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“The book does a terrific job of explaining the tax code. The tax advice … is on target and has depth. Smart chapters — not just thumbnail sketches — for filling out forms.”
—Gannett News Service
“Among tax advice books is far and away the best. Taxes For Dummies is fun to read and teaches about the tax system itself. The book also provides excellent advice about dealing with mistakes — created by you or the Internal Revenue Service. And it talks about fitting taxes into your daily financial planning. In other words, it’s a book you can use after April 15, as well as before.”
—Kathy M. Kristof, Los Angeles Times
“The best of these books for tax novices. Substitutes simple English for tax-code complexities.”
—Worth magazine
“User-friendly income-tax preparation and sound financial advice you can use throughout the year.”
—The Seattle Times
“This book is the most accessible and creative. It’s also the best organized of the lot, presenting information in the order you need it to complete your tax forms.”
—USA Today
“Taxes For Dummies will make tax preparation less traumatic… . It is a book that answers — in plain English, and sometimes with humor — many puzzling questions that arise on the most commonly used tax forms.”
—Stanley Angrist, The Wall Street Journal
“This is a lot of book for the money, filled with good examples … and level-headed advice. It follows the line-by-line format but also has year-round reference value for taxpayers who plan ahead… . A human heart beats in this highly intelligent tax tome.”
—Michael Pellecchia, syndicated columnist
“— Highest rated among the annual tax guides … superb writing and friendly organization.”
—Publishers Weekly
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Taxes For Dummies®, 2024 Edition
Published by: John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030-5774, www.wiley.com
Copyright © 2024 by Eric Tyson and Margaret Atkins Munro
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Published simultaneously in Canada
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Introduction
Welcome to Taxes 2024 For Dummies — the latest up-to-date revision of our best-selling book (the first edition of which was published in 1994) by your humble co-authors — Eric Tyson, Margaret Atkins Munro, and David J. Silverman. These pages answer both your tax-preparation and tax-planning questions in plain English and with a touch of humor.
About This Book
Our book can help you make sense of the tax laws, especially the newest ones. We promise to help relieve your pain and misery (at least the tax-related portion), legally reduce your income tax bill, and get you through your tax return with little discomfort.
We also help you keep your mind on your taxes while you plan your finances for the upcoming year. 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, we highlight how any resulting changes may affect important decisions you’ll need to make in the years ahead.
In addition to helping you understand how to deal with federal income taxes, we explain how to handle and reduce some of those pesky and not-so-insignificant taxes slapped on by states and other tax-collecting bodies.
We also show you how to steer clear of running afoul of tax laws. The fact that Congress keeps changing the tax rules makes it easy for honest and well-intentioned people to unknowingly break those laws. We explain how to clear the necessary hurdles to keep the taxing authorities from sending threatening notices and bills. But if you do get a nasty letter from the tax police, we explain how to deal with that frightful situation in a calm, levelheaded manner so that you get the IRS off your back.
Throughout this book, we provide line-by-line and step-by-step instructions on how to fill out various tax forms and give examples of what these forms look like. If ever you need to look up a form or print one out, simply go to www.irs.gov and type the form name in the search box.
Foolish Assumptions
At their worst, some annual tax-preparation books are as dreadful as the IRS instruction booklets themselves — bulky, bureaucratic, and jargon-filled. In particular cases, preparation books simply reproduce dozens of pages of IRS instructions! At their best, these books tell you information you can’t find in the IRS instructions — but the golden nuggets of tax information often are buried in massive piles of granite. Taxes 2024 For Dummies lays out those golden nuggets in nice, clean display cases so that you won’t miss a single one. There’s still plenty of granite, but we don’t use it to bury you — or key insights!
We each have decades of experience providing personal financial and tax advice to real people just like you. We understand your tax and financial concerns and know how to help solve your quandaries!
Most people’s tax concerns fall into three categories: filling out their forms properly, legally minimizing their taxes, and avoiding interest and penalties. Taxes 2024 For Dummies addresses these concerns and helps take some of the pain and agony out of dealing with taxes.
We’ve made some assumptions on how you may want to use this book. Here are the various practical ways that we figure you will use Taxes 2024 For Dummies to complete your forms, legally reduce your taxes, and avoid penalties:
As a reference:
For example, maybe you know a fair amount about your taxes, but you don’t know where and how to report the dividends you received from some of your investments. 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 22
, 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 us a note and let us know of your achievement!
Icons Used in This Book
This target marks recommendations for making the most of your taxes and money (for example, paying off your nontax-deductible credit-card debt with your lottery winnings).
The info by this friendly sign is useful if you want to discover ways to reduce your taxes — and all the suggestions are strictly legit.
This icon is a friendly reminder of stuff we discuss elsewhere in the book or of points we really want you to remember.
This alert denotes common, costly mistakes people make with their taxes.
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!
Throughout this book, we highlight new tax provisions with this icon. Although searching for and reading passages marked with this icon quickly tells you what’s new, don’t overlook the many tax-reducing strategies and recommendations throughout the rest of the book.
Some tax problems are too complex to be handled in any one book. If you’re one of the unlucky ones who’s in a tax situation that can spell big trouble if you get it wrong, consult a tax advisor to be on the safe side. We tell you how to select one in Chapter 2.
Beyond the Book
In addition to the material in the print or e-book you’re reading right now, this product also comes with some access-anywhere info on the web. Go to www.dummies.com and type in “Taxes 2024 For Dummies Cheat Sheet” in the search box to discover some tax-wise pointers.
Where to Go from Here
There are numerous different ways that readers tell us that they use our book. If you’re on a deadline to complete your Form 1040 U.S. income tax return, you can turn to those chapters in Parts 2 and 3. If you’ve got an audit or other notice from the IRS and want advice on that, see Part 4. If you’d like a good overview on the tax system and are trying to make wise year-round tax decisions, check out the other Parts, especially Part 5.
Part 1
Getting Ready to File
IN THIS PART …
Make sense of the federal income tax system.
Understand your tax return preparation options.
Keep your tax documentation organized.
Know your filing status and other options.
Chapter 1
Understanding the U.S. Tax System
IN THIS CHAPTER
Making sense of the U.S. tax system
Figuring out your income tax rate
Checking out recent tax laws and possible changes
Most people — including your humble authors — find taxes to be tedious. First, everyone faces the chore of gathering various complicated-looking documents to complete the annual ritual of filling out IRS Form 1040 and whatever form your state may require.
You may need to become acquainted with some forms that are new to you. Perhaps you need to figure out how to submit a quarterly tax payment when you no longer work for a company and now receive self-employment income from independent contract work. Maybe you sold some investments (such as stocks, mutual funds, or real estate) at a profit (or loss), and you must calculate how much tax you owe (or loss you can write off).
Unfortunately, too many people think of taxes only in spring, when it comes time to file that dreadful annual return. Throughout this book, you can find all sorts of tips, suggestions, and warnings that help you discover the important role that your taxes play in your entire personal financial situation year-round. In fact, we devote Part 5 of the book to showing you how to accomplish important financial goals while legally reducing your taxes.
We hope that you include our book as an understandable resource you can count on. Taxes 2024 For Dummies helps you discover how the tax system works and how to legally make the system work for you. You’ll quite possibly be bothered by some of the things this book shows you that don’t seem fair. But getting angry enough to make the veins in your neck bulge definitely won’t help your financial situation or your blood pressure. (We don’t want to see your medical deductions increase!) Even if you don’t agree with the entire tax system, you still have to play by the rules.
Figuring Out the U.S. Tax System
Whenever money passes through your hands, it seems that you pay some kind of tax. Consider the following:
When you work and get paid, you pay federal, state, and local taxes (on top of having to deal with the migraines your bosses and difficult customers give you).
After paying taxes on your earnings and then spending money on things you need and want (and paying more taxes in the process), you may have some money left over for investing. Guess what? Your reward for being a saver is that you also pay tax on some of the earnings on your savings.
You’ll pay more in taxes than you need to if you don’t understand the tax system. Unfortunately, when you try to read and make sense of the tax laws, you quickly realize that you’re more likely to win the lottery than figure out some parts of the tax code! That’s one of the reasons that tax attorneys and accountants are paid so much — to compensate them for their intense and prolonged agony of deciphering the tax code!
A BRIEF HISTORY OF U.S. INCOME TAXES
Federal income taxes haven’t always been a certainty. In the early 20th century, people lived without being bothered by the federal income tax — or by televisions, microwaves, computers, smartphones, and all those other complications. Beginning in 1913, Congress set up a system of graduated tax rates, starting with a rate of only 1 percent and going up to 7 percent.
This tax system was enacted through the 16th Amendment to the Constitution, which was suggested by President Teddy Roosevelt, pushed through by his successor (President William H. Taft), and ultimately ratified by two-thirds of the states.
In fairness, we must tell you that the 1913 federal income tax wasn’t the first U.S. income tax. President Abraham Lincoln instituted a Civil War income tax in 1861, which was abandoned a decade later.
Prior to 1913, the vast majority of tax dollars collected by the federal government came from taxes levied on goods, such as liquor, tobacco, and imports. Today, personal income taxes, including Social Security taxes, account for about 85 percent of federal government revenue.
In 1913, the forms, instructions, and clarifications for the entire federal tax system would have filled just one small three-ring binder. (And we’re not even sure that three-ring binders existed back then.) Those were, indeed, the good old days. Since then, thanks to endless revisions, enhancements, and simplifications, the federal tax laws — along with the IRS and court clarifications of those laws — can (and should) fill several dump trucks.
But here’s a little secret to make you feel much better: You don’t need to read the dreadful tax laws. Most tax advisors don’t read them themselves. Instead, they rely upon summaries prepared by organizations and people who have more of a knack for explaining things clearly and concisely than the IRS does. Wolters Kluwer — the organization responsible for technically reviewing this fine book — has compiled a Federal Tax Reporter publication that details and explains all federal tax laws. This publication now has in excess of 80,000 pages!
Even if your financial life is stagnant, recent tax law changes may require you to complete some new forms and calculations. And, if you’re like most people, you’re currently missing out on some legal tax reduction tactics.
You can reduce your taxes
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 (allowable deductions) to encourage people to own homes (see Chapter 25). But if you don’t understand these tax benefits, you probably don’t know how to take full advantage of them, either.
Even when you’re an honest, earnest, well-intentioned, and law-abiding citizen, odds are that you don’t completely understand the tax system. This ignorance wreaks havoc with your personal finances because you end up paying more in taxes than you need to.
Adding insult to injury, you may step on a tax land mine. Like millions of taxpayers before you, you can unwittingly be in noncompliance with the ever-changing tax laws at the federal, state, and local levels. Your tax ignorance can cause mistakes that may be costly if the IRS and your state government catch your errors. With the proliferation of computerized data tracking, discovering errors has never been easier for the tax cops at the IRS. And when they uncover your boo-boos, you have to pay the tax you originally owed, interest, and possibly penalties. Ouch!
So 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 rain forest with a dinner knife. That’s why, throughout this book, we help you understand the tax system, and we 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 we present in this book. Here are some things to consider:
You may be able to tax-shelter your employment earnings into various retirement accounts such as 401(k) and SEP-IRA plans. This strategy slashes your current income taxes, enables your money to grow tax-free, and helps you save toward the goal of retirement.
The less you buy, the less sales tax you pay. You can buy a less costly, more fuel-efficient car, for example. (You’ll spend less on gasoline, including gasoline taxes, as well.)
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.
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.
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 we know — is limited, you need to understand the tax code to make it work for you and help you accomplish your financial goals. The following case studies demonstrate the importance of keeping in mind the tax implications of your financial decisions throughout the year.
The costs of procrastination
Consider the case of Sheila and Peter, the proud owners of a successful and rapidly growing small business. They became so busy running the business and taking care of their children that they hardly had time to call a tax advisor. In fact, not only did they fail to file for an extension by April 15, but they also didn’t pay any federal or state income taxes.
By August, Peter and Sheila finally had time to focus on the prior year’s income taxes, but by then they had gotten themselves into some problems and incurred these costs:
A penalty for failure to file, which is 5 percent per month of the amount due, up to a maximum of 25 percent (for five months).
Interest on the amount due. (
Note:
This rate is adjusted over time based on current interest rate levels.)
A larger tax bill (also caused by lack of planning), which turned out to be far more expensive than the first two expenses. Because they had incorporated their business, Peter and Sheila were on the payroll for salary during the year. Despite the high level of profitability of their business, they had set their pay at too low a level.
A low salary wouldn’t seem to be a problem for the owner and only employee of a company. The worst that you’d think could happen to Peter and Sheila is that they may have to eat more peanut butter and jelly sandwiches during the year. But because they received small salaries, the contributions they could make to tax-deductible retirement accounts were based on a percentage of only their small salaries.
Loss of future investment earnings, which means that over time Sheila and Peter actually lost more than the additional taxes. Not only did Peter and Sheila miss out on an opportunity to reduce their taxes by making larger deductible contributions to their tax-sheltered retirement accounts, but they also lost the chance for the money to compound (tax-deferred) over time.
The consequences of poor advice
Getting bad advice, especially from someone with a vested interest in your decisions, is another leading cause of tax mistakes. Consider the case of George, who sought counsel about investing and other financial matters. When he received a solicitation from a financial advisor at a well-known firm, he bit. The polished, well-dressed lad was actually a broker (someone who earns commissions from the financial products that they peddle) who prepared a voluminous report complete with scads of retirement projections for George.
Part of the advice in this report was for George to purchase some cash-value life insurance and various investments from the broker. The broker pitched the insurance as a great way to save, invest, and reduce George’s tax burden.
Through his employer, George can invest in a retirement account on a tax-deductible basis. However, the broker conveniently overlooked this avenue — after all, the broker can’t earn fat commissions by telling people like George to fund their employers’ retirement accounts. As a result, George paid thousands of dollars more in taxes annually than he needed to, not to mention those fat, and unnecessary, commissions.
Funding the life insurance policy was a terrible decision for George, in large part because doing so offered no upfront tax breaks. When you contribute money to tax-deductible retirement accounts, such as 401(k) plans, you get to keep and invest money you normally would’ve owed in federal and state income taxes. (See Chapter 22 to find out more about retirement accounts and check out Chapter 24 for the other reasons why life insurance generally shouldn’t be used as an investment.)
Understanding Your Income Tax Rates
Many people remember only whether they received tax refunds or owed money on their tax returns. But you should care how much you pay in taxes and the total and the marginal taxes that you pay, so you can make financial decisions that lessen your tax load.
Although some people feel happy when they get refunds, you shouldn’t. All a refund indicates is that you overpaid your taxes during the previous year. When you file your income tax return, you settle up with tax authorities regarding the amount of taxes you paid during the past year versus the total tax that you actually are required to pay, based on your income and deductions.
Adding up your total taxes
The only way to determine the total amount of income taxes you pay is to get out your federal and state tax returns. On each of those returns, well before the end, is a line that shows the total tax. Add the totals from your federal and state tax returns, and you probably have one of the largest expenses of your financial life (unless you have an expensive home or a huge gambling habit).
You need to note that your taxable income is different from the amount of money you earned during the tax year from employment and investments. Taxable income is defined as the amount of income on which you actually pay income taxes. You don’t pay taxes on your total income for the following two reasons. First, not all income is taxable. For example, you pay federal income tax on the interest that you earn on a bank savings account but not on the interest from municipal bonds (loans that you, as a bond buyer, make to state and local governments).
A second reason that you don’t pay taxes on all your income is that you get to subtract deductions from your income. Some deductions are available just for being a living, breathing human being. For tax year 2023, single people receive an automatic $13,850 standard deduction, heads of household qualify for $20,800, and married couples filing jointly get $27,700. (People older than 65 and those who are blind get slightly higher deductions.) Other expenses, such as mortgage interest and property taxes, are deductible to the extent that your total itemized deductions exceed the standard deductions.
A personal budget or spending plan that doesn’t address your income taxes may be doomed to failure. Throughout this book we highlight strategies for reducing your taxable income and income taxes right now and in the future. Doing so is vital to your ability to save and invest money to accomplish important financial and personal goals.
Following your marginal income tax rate
Marginal is a word that people often use when they mean small or barely acceptable. Sort of like getting a C– on a school report card (or “just” an A– if you’re from an overachieving family). But when we’re talking taxes, marginal has a different meaning. The government charges you different income tax rates for different portions of your annual income. So your marginal tax rate is the rate that you pay on the last dollars you earn. You generally pay less tax on your first, or lowest, dollars of earnings and more tax on your last, or highest, dollars of earnings. This system is known as a graduated income tax, a system noted in Greece as far back as 2400 B.C.
Our advice is to keep an open mind, listen to all sides, and remember the big picture. Back in the 1950s (an economic boom time), for example, the highest federal income tax rate was a whopping 90 percent. And whereas during most of the past century the highest income earners paid a marginal rate that was double to triple the rate paid by moderate income earners of the time, that gap was reduced during the past generation. Still, the highest income earners continue to pay the lion’s share of taxes. In fact, using the latest IRS data, the Tax Foundation recently found the top 1 percent of all income earners pay about 42 percent of all federal taxes (while earning 22 percent of all income). The top 10 percent pay about 74 percent of the total individual income taxes collected (while earning 49 percent of all income).
The fact that not all income is treated equally under the current tax system isn’t evident to most people. When you work for an employer and have a reasonably constant salary during the course of a year, a stable amount of federal and state taxes is deducted from each of your paychecks. Therefore, you may have the false impression that all your earned income is being taxed equally.
Table 1-1 gives the 2023 federal income tax rates for singles and for married people filing jointly.
Table 1-1 2023 Federal Income Tax Brackets and Rates
Federal Income Tax Rate
Single Filers Tax Brackets
Married Couples Filing Jointly Tax Brackets
10%
Up to $11,000
Up to $22,000
12%
$11,000 to $44,725
$22,000 to $89,450
22%
$44,725 to $95,375
$89,450 to $190,750
24%
$95,375 to $182,100
$190,750 to $364,200
32%
$182,100 to $231,250
$364,200 to $462,500
35%
$231,250 to $578,125
$462,500 to $693,750
37%
$578,125 or more
$693,750 or more
Remember that your marginal tax rate is the rate of tax that you pay on your last, or so-called highest, dollars of taxable income. So, according to Table 1-1, if you’re single and your taxable income during 2023 totals $60,000, for example, you pay federal income tax at the rate of 10 percent on the first $11,000 of taxable income. You then pay 12 percent on the amount from $11,000 to $44,725 and 22 percent on income from $44,725 up to $60,000. In other words, you effectively pay a marginal federal tax rate of 22 percent on your last dollars of income — those dollars in excess of $44,725.
After you understand the powerful concept of marginal tax rates, you can see the value of the many financial strategies that affect the amount of taxes you pay. Because you pay taxes on your employment income and on the earnings from your investments other than retirement accounts, many of your personal financial decisions need to be made with your marginal tax rate in mind. For example, when you have the opportunity to moonlight and earn some extra money, how much of that extra compensation you get to keep depends on your marginal tax rate. Your marginal income tax rate enables you to quickly calculate the additional taxes you’d pay on the additional income.
Conversely, you quantify the amount of taxes that you save by reducing your taxable income, either by decreasing your income — for example, with pretax contributions to retirement accounts — or by increasing your deductions.
Actually, you can make even more of your marginal taxes. In the next section, we detail the painful realities of income taxes levied by most states that add to your federal income burden. If you’re a higher income earner, see the section later in this chapter where we discuss the Alternative Minimum Tax. And as we discuss elsewhere in this book, some tax breaks are reduced when your income exceeds a particular level — here are some examples:
Education tax breaks:
There are numerous education tax deductions and credits, the rules for which continue to evolve and change. All of these helpful tax breaks, however, are subject to income limitations (see
Chapter 26
to plan ahead and get more specifics).
Saver’s credit:
The saver’s credit rewards lower-income earners with federal income tax credits on Form 8880 (Credit for Qualified Retirement Savings Contributions). This credit phases out in 2023 for single taxpayers with adjusted gross income (AGI) above $36,500 and for married couples filing jointly at AGIs above $73,000.
Rental real estate losses:
If you own rental real estate, you may normally take up to a $25,000 annual loss when your expenses exceed your rental income. Your ability to deduct this loss begins to be limited when your AGI exceeds $100,000.
Roth IRA contributions:
Your eligibility to fully contribute to Roth individual retirement accounts (IRAs; see
Chapter 20
) for 2023 depends on your modified AGI being less than or equal to $153,000 if you’re a single taxpayer or $228,000 if you’re married. Beyond these amounts, allowable contributions are phased out.
Your marginal income tax rate — the rate of tax you pay on your last dollars of income — should be higher than your average tax rate — the rate you pay, on average, on all your earnings. The reason your marginal tax rate is more important for you to know is that it tells you the value of legally reducing your taxable income. So, for example, if you’re in the federal 24 percent tax bracket, for every $1,000 that you can reduce your taxable income, you shave $240 off your federal income tax bill.
States want in on the income tax action, too
Note that your total marginal rate includes your federal and state income tax rates. As you may already be painfully aware, you don’t pay only federal income taxes. You also get hit with state income taxes — that is, unless you live in Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, or Wyoming. Those states have no state income taxes. As is true with federal income taxes, state income taxes have been around since the early 1900s.
You can look up your state tax rate by getting out your most recent year’s state income tax preparation booklet. Alternatively, check out the map showing the top marginal income tax rates (see Figure 1-1). This chart reflects state individual income taxes. Some states impose other taxes, such as local, county, or city taxes, special taxes for nonresidents, or capital gains taxes, which aren’t included in this table.
The second tax system: Alternative Minimum Tax
There’s actually a second federal income tax system (yes, we groan with you as we struggle to understand even the first complicated tax system). This second system may raise your income taxes higher than they’d otherwise be.
In 1969, Congress created a second tax system — the Alternative Minimum Tax (AMT) — to ensure that higher-income earners with relatively high amounts of itemized deductions pay at least a minimum amount of taxes on their incomes.
If you have a bunch of deductions from state income taxes, real estate taxes, certain types of mortgage interest, or passive investments (such as limited partnerships or rental real estate), you may fall prey to the AMT. The AMT is a classic case of the increasing complexity of our tax code. As incentives were placed in the tax code, people took advantage of them. Then the government said, “Whoa, Nelly! We can’t have people taking that many write-offs.” Rather than doing the sensible thing and limiting some of those deductions, Congress created the AMT instead.
Source: Tax Foundation.org
FIGURE 1-1: Income state tax rates for each state.
