Our tax system would have a pretty hard time being more complex. If you are like most Americans, you hear terms like tax deductions, tax credit, adjusted gross income and you want to know more, but you never really do any research. It is not until you really need to know what a tax term means that you finally pay attention and figure it out. What if you found out that you may be paying more taxes because these terms? Would you want to know more? I thought so.
Let’s start with the basics. A tax deduction is something that lowers your tax liability. In other words, a deduction allows you to take some amount of your income for the year and not have to pay taxes on it. If you paid taxes on 30% of your income, a deduction of $1000 saves you that 30% you would have paid or $300. Tax deductions are often confused with tax credits. A credit comes straight off of the taxes you pay. So rather than saving 30% of your money, you save 100% of that money.
A tax deduction helps you lower your adjusted gross income. To define adjusted gross income, it is simply the amount of income you have after you have subtracted all of your deductions. Why does this matter? Your tax bracket is determined by your adjusted gross income and not your total income. The more deductions you have, the lower your adjusted gross income will be, and the lower tax bracket in which you will be. Tax brackets are important because the higher bracket you are in, the higher percentage of taxes you will pay.
Let’s work through an example. The 2008 federal tax brackets say that taxpayers filing with a status of single will pay 10% on all income between $0 and $8,025. They will pay 15% on all income between $8,025 and $32,550. If they fall into the 15% tax bracket, they will also pay the 10% on the $8,025. For our example, we will say that Mike makes $20,025. Taking no deductions into account, Mike would pay his 10% for the first bracket or $802.50. Mike would also pay 15% on the rest (20,025 – 8,025) * 15% = $1800. Add those together and Mike pays $2602.50 in taxes. Ouch! Deductions would have helped Mike. Here is how.
Mike owns his house. He pays a mortgage. One tax deduction available to homeowners is that all interest paid on the mortgage is tax deductible. You can see that in order for Mike to get into the lower tax bracket completely, he would need $12,000 in deductions. However, every dollar of tax deduction he does have is less he pays at the higher 15%. If Mike paid $6,000 in mortgage interest last year, he can deduct that and bring his adjusted gross income down to $14,025. Now the amount he pays at 15% is (14,025 – 8,025) or $6,000 instead of $12,000. He pays $900 instead of $1800. He saved $900 in taxes! If Mike would have paid that $6,000 in rent instead of to a mortgage, he would have paid Uncle Sam $900 extra dollars.
Some common places to watch out for tax deductions or other items that lower your adjusted gross income are 401K plans at work, charitable contributions, child-care costs, vehicle license tax, interest on first and second mortgages, losses on investments, interest paid on student loans, property taxes and contributions to IRAs.
Using tools such as TurboTax and TaxAct will help you make sure you don’t miss out on any tax deduction to which you are entitled. Click here to file your federal return for FREE.
Don’t forget April 15th is the deadline!
Ken Rios is a contributor to IncomeTaxes1040.com, a site
dedicated to helping you grow your tax knowledge. For more articles and information on taxes
please visit IncomeTaxes1040.com.
It is that time of the year when millions of Americans are rushing to complete there income tax returns by the April 15 and pay what they owe to the IRS; or if they are lucky, hope that IRS will send them a refund check. During the economic boom, when the times were good and revenues hit the record numbers, American businesses and average citizens used CPA s and other tax services to prepare their filing forms and pay Uncle Sam what they owed; today picture is rather different.
When the recession hit, as was expected, people started cutting on nonessential expenses. This included the tax services as well. People started using free hotlines, community tax advisors and online services that usually offer substantial discounts and even coupons to get in to the growing market of virtual tax services.
In order to save money, ordinary Americans started preparing their own tax returns. There is a substantial literature available in the public libraries that can help prepare a simple tax return; after all, once you receive your W2, it is just a matter of filling out a form 1040 (assuming you do not have any deductions and additional income that will complicate your filing procedure). Local TV and radio stations often have hotlines set up for tax questions. Community services offer free tax advice and there is always an IRS community center set up that offers free consultations for the tax filing season.
In the last decade, internet service sector (which includes online tax services) has seen an enormous increase in users and subsequently in revenues. During the hard economic times companies like H&R Block and Jackson Hewitt are trying to increase their market share in an increasingly profitable industry segment that has a long term potential.
People tend to use online service since it is faster and usually cheaper than CPA’s services. Method is called “efiling” and according to the H&R Block’s web site that references IRS statistics, 60% of all returns filed so far this year were efiles.
Software like TurboTax have seen an increase in revenues as well; it is not surprising, since it is a onetime investment that can be updated every year and used to prepare tax returns. It offers convenience of personalized services such as personal deduction calculators, tax return checkups (look for errors and potential deductions) and backup in case you will get audited by the IRS.
Marketing campaigns to increase the market share in the virtual tax service industry is gaining the momentum; H&R Block and TurboTax are just some of the examples of the companies that offer online discount coupons. For example, a user can print a $20.00 H&R Block coupon that he or she can present when visiting the office and get a discount. Turbo tax offers similar discounts in the forms of coupons that can be used at the checkout when buying the software. If you are interested in obtaining one, just Google the words: “online tax coupons” and you will be directed to multiple websites that offer them.
Online businesses and especially financial services have been experiencing a steady growth for the past decade. Tax services market is expected to continue to grow in the coming decade; it is cheaper and it is faster than using a CPA and mailing your forms to the IRS. So, in the future, any company that expects to stay in business will be offering their services online; it is very likely that they will do it for a lower fee than it is accepted today as a standard. All you have to do is look for them to take advantage of a faster and cheaper service.
It’s almost April 15th, and my husband just bounded down the stairs to announce that he finally finished up what needed to be done to submit our taxes for the year. Some years we make it by the deadline, some years we don’t. We both work on commission, and depending on the how the year went, we’re less excited about this time of year than others. When we actually don’t file an extension, we’re kind of proud of ourselves. It got me to thinking about paying Uncle Sam, and what one advantage we have working in our favor. We are homeowners.
So what’s the big deal about being a homeowner when tax time rolls around? Well, what many people who have never owned a home may not know is that your mortgage is not only your largest debt, but also it can be your largest write off as well. (And honestly, there are probably plenty of homeowners out there whose accountants prepare their taxes for them, and they never really noticed how much this write off counts!).
This time of year, many folks are digging through file folders, nooks and crannies to find charity receipts, business receipts and any other write off they can remember. How does the old saying go? You can’t escape death or taxes. And tax time can make you feel like your facing death anyway. But what some people who’ve never owned a home don’t realize is that you can deduct all the interest from the past year you’ve paid monthly on your mortgage payment from your annual gross income. Yep. You read that correctly. And may I remind you that during the honeymoon phase of your mortgage repayment, the majority of what you pay (unless it’s an interest only loan) goes toward interest, not principal reduction. So think about it: potentially, this tax deduction could pop you into a lower tax bracket if the numbers work out.
In January of every year, your mortgage servicer will send you a statement that reflects the amount of interest you paid, and you can reflect this amount on your 1040 as a deduction (or you can tally up the amount from your checkbook). What’s more, unlike the majority of deductions, you get to count ALL of the interest portion of your payments you made last year. So, buying a home versus renting can make even more sense for you. Not only are you living in a home that will increase in value over time, you also have all that interest to write off in April. Sounds like a win-win situation to me.
Understandably, the tax break is only a side benefit to owning a home. The biggest value is having a place to call your own that you and your family love. But, writing a smaller check come April sure would feel good, too. Don’t you agree? So, if you’ve been considering buying a home, perhaps this bit of knowledge will be the final nudge that makes you move forward. And next year, you can look forward to a new advantage at tax time.
