13 basic tax lessons
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of these restrictions refer to them as "stealth" or "backdoor"
taxes that effectively raise taxes without increasing tax rates.
changes over the past few years have eased these limits somewhat by allowing filers
to make more money before losing various tax benefits. But be aware that they
still exist, and your tax-cutting efforts could run straight into them.
Deductibility has its boundaries
Don't be duped by deductibility
claims. While deductions are a valuable tax-reduction method, many have limits.
taxpayers encounter this issue when they make charitable donations. Say, for example,
last year you wrote your favorite nonprofit a $500 check. To claim it as a deduction,
you must itemize. But when you fill out your 2008 return, you note that as a single filer, you're allowed a standard deduction of $5,450. If your only itemized deduction
is that $500 charitable gift, it will still help the charity but not your tax
bill, since you'll take the larger standard amount.
you do itemize, some deductions must meet a threshold before they help you. Only
medical expenses that exceed 7.5 percent of your adjusted gross income can be
deducted. Similarly, miscellaneous expenses must total more than 2 percent of
your income or they are of no tax value.
Being aware of deductibility
limits can help you establish a tax strategy to get around them. One approach
is bunching, where you concentrate your deductible expenses in one year so you
can itemize. Then the next year, you might take the standard amount. It might
make sense to alternate your deduction method between standard and itemized from
one year to another.
Earned and unearned are taxed differently
In addition to the regular
tax brackets, your income is taxed differently depending on how you acquire it.
The IRS generally characterizes income as earned or unearned.
rule of thumb for earned income is that it comes from a business activity. This
includes money you get from your job, either by hourly wages or salary, along
with tips, bonuses and some fringe benefits. It also covers any self-employment
money you make, either as your main work or a part-time job.
income typically comes from investment sources, inheritances or what the IRS calls
passive activities, such as rents from property you own. Much of unearned income
is taxed at different rates than ordinary income. You face lower rates, for example,
on capital gains and dividends you receive.
But a lot of unearned income, even
with its lower rates, isn't necessarily good. You could be closing other tax avenues.
"You have to have earned income to make
an IRA contribution," says LeValley-Cocovinis. "Eligibility for a lot of credits
also depends on earned income.
"You might think, 'Oh,
I'm getting away with something.' Yes, you are, but you could be missing out,
too. If you're playing with getting earned income down, you're cheating yourself
in other ways, like Social Security.
"Like it or not,
you're paying into it, so you should get what you deserve."
Extension to file means just that
The IRS allows you more time to
get your return in and even simplified the process. Now, you only have to file
Form 4868 to get six more months to complete your taxes. Previously it was a two-step,
|-- Updated: Feb. 13, 2009