Monthly Tax Tips Category

I wanted to create a post to give taxpayers a better look into what tax increases occurred and who was affected by them. Without further ado:

Adjusted Gross Income of less than $200k (single) $250k (married)

  • Increase on payroll and self employment taxes of 2% up to $113,700 per wage earner
    • A two income household that makes $250k could see a tax increase of up to $4,548

Adjusted Gross Income of between $200k and $400k (single), $250k and $450k (married)

  • Increase on payroll and self employment taxes of 2% up to $113,700 per wage earner
    • A two income household that makes $250k could see a tax increase of up to $4,548
  • Phase out personal exemptions – typically $3800 per member of the household
    • 2 percent reduction for every $2,500 in adjusted gross income over $250k (single) and $300k (married)
    • For example:  if you file Single, and make $260,000 in adjusted gross income. The value of the personal exemption for the 2012 tax year is $3,800. Because this filer is $10,000 over the income threshold, the value of his personal exemption would fall 8 percent, or $304
      • Once the taxpayer reaches $375k single and $425k married, the will completely lose their personal exemptions
  • Phase out of Itemized deductions
    • Itemized deductions are reduced by 3 percent of the actual adjusted gross income above the threshold – $250k (single) and $300k (married)
    • Using the example above of a single taxpayer with adjusted gross income of $260,000, being $10,000 over the threshold means his itemized deductions would be reduced by $300, or 3 percent of $10,000.
    • It’s important to note that the reduction would be capped at 80 percent of total itemized deductions.
  • Increased Capital Gains of 3.8% (18.8% total)

Adjusted Gross Income higher than $400k (single) and $450k (married)

  • ALL of the above.. plus:
  • Increased Capital gains rates of 8.8% (23.8% total)
  • Increased Qualified Dividends rate of 5% (20% total)
  • Increased Ordinary tax rate above thresholds of 4.6% (39.6% total)

Additional Tax Increases

  • Estate tax increase of 5% (to 40% total)
    • Note: The estate tax exemption will remain the same at $5,120,000 (adjusted for inflation)
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Here is a simple post describing a very basic perspective of personal income taxes.

ALL Income is taxable – this one baffles people sometimes, the IRS wants it all, even the sales on Craigslist. The only reason that you arent getting mailed a tax bill for that stuff is that this information does not get reported to the IRS. Some of the items that DO get reported to the IRS are: W2 income, 1099 income, stock sales, interest/dividend income, sale of home, alimony, pension income.

Only certain expenses are deductible – Only certain expenses can be deducted off of your tax return and there is a threshold that you have to reach to make it even kick in. Some of the major expenses that can be deducted: Mortgage interest, Property taxes, Car registration fees, Donations, Employee expenses that have not been reimbursed by your employer.

The threshold varies depending on how you file, but use $5700 if you are single, or $11400 if you are married as a guidline. So you will need MORE than those amounts in order to get any benefit, for example, if you have a total of $5900 and you are single, then the benefit you get is $200 more than if you didnt include any deductions at all.

Everyone gets a standard deduction – Everyone except someone who is claimed as a dependent of someone else gets and exemption. Think of the standard deduction and exemption as reducing your taxable income, its the IRS’s gift to you for being so awesome. The numbers can range whether you are single or married. Every dependent (child/relative) you claim gives you one extra exemption, lowering your taxable income.

Credits – credits are used as extra money, they are given because something special happened. The most used credit is the child tax credit which gives you $1000 for each child you claim under 17. There are many other credits, but that will be in a different post.

Tax – Tax is calculated based on your taxable income, it is a graduated scale, so 10% of the first $15,000 and 15% of the next 15,000, etc. It is designed so that people who make more money, pay more money.

That concludes the basics, taxes 101. In Taxes 102 we will look more at filing status and who must file a tax return.

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In this post, I hope to provide a few tips to lower your tax bill. I also want to emphasize, that although this is about taxes mostly, its also about putting yourself in a better financial position overall.

Donate – if you have itemized deductions, i.e. mortage interest, a good way to lower your taxes is to donate. Fortunately it also makes you feel good. Giving items to the goodwill can get you $500 (*max), giving cash is a deduction of whatever tax bracket you are in. (*anything over $500 must be itemized, anything over $5,000 must be appraised).

Start a business – The single best way to minimize taxes. Starting a business is absolutely amazing. You can read more about this here

Max your 401k – most people dont realize that they can contribute up to $16,500 (going to $17,000 in 2012). This is a pre-tax benefit. If your not living paycheck to paycheck, this is a much better option then putting your money in a savings account. If you need the money, you can always borrow on your account, and the interest you pay goes back into the retirement account.

Tally up your employee related expenses – Although there is a limitation of 2% of your income, you may still qualify for a deduction. Did your work make you drive anywhere other than commuting? Did you have to buy uniforms, tools, supplies, continuing education, dues? All those could be tax deductible.

Have Kids! and if you do, then put them in daycare - This is an easy one, well maybe not, but the credit is $1000 and if you put them in daycare, you can get a small tax credit for daycare expenses, typically 20-35%. Doing just this can potentially open some time to start a business, or manage a rental property!

Buy a Rental - Typically rentals are tax neutral, and sometimes tax beneficial. Either way, in this market you should be able to find an inexpensive property and make the numbers work to make a net income of $200-300 dollars a month, with a low down payment. Tax wise, it makes sense: $300 a month tax free for a $5000 down payment. If you have the free time to manage the property, this is definitely a good way to increase your net worth

 

 

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I get a lot of questions about what is deductible, and what a business owner can use to lower their tax liability.

Before I get into that, a primer: It is fantastic that you are going to start building up a business. You will find that the tax benefits can be very good. You must realize that business deductions and strategy are NOT static. Once you hit certain revenue milestones, you may be suited for additional deductions that may not have benefited you before. For example, if the net income your business makes reaches $5,000 or more, it may be smart to set up an S-Corporation for the tax benefits.

As far as what expenses you can write off:

  1. Open a business checking account, or business credit card, only use that account for business expenses (if you can and it’s convenient to do so). If you do make any expenses on your personal account, make sure to keep a receipt.
  2. Try and keep receipts (or bank statement records) for absolutely everything you spend your money on that is business related. You will find that most everything is tax deductible. A few examples: Business Meals, Entertainment, Advertising, Professional Services, Rent, Utilities, Phone, Fax, Supplies, Shipping fees. (the point is, keep all of your receipts)
  3. Track your mileage you drive for your business, this can be approximate. Keep utility bills and cell phone bills, part of those will be deductible.

This is a great starting point. I make another post on this blog on when you start making revenue of $20,000 or more (or net income of $5,000 or more).

The tax deductions can be exceptional, I can tell you about all sorts of great things that you can include as business expenses as your business grows. As far as right now since you are just starting, it would be good to keep it simple and not add too much work and confusion. Typically these more complex deductions start helping as you begin earning more revenue.

A TON of people ask me how to lower their tax bill at the end of the year, they also ask how to save for retirement. Low and behold there is a way to do both without investing in a 401k that relies on a crazy stock market!

Starting a business:

Many people get scared when I tell them this, things go through their mind like: Fictitious business names, business licenses, laws, regulations, corporations, S-corps, LLCs.

My advice, forget all that stuff for now, I will go over that in a little bit.

Right now, think about something that you enjoy doing, something that you could potentially make money from. A few simple examples: Dog Walking, Personal training (lifting weights), Construction (handyman), Child care, Teaching (home schooling), internet sales (pretty much any niche product). Those are just a few, it took me 5 minutes to think of those, there are a ton more.

Once you have an idea of what you like to do, come up with a way you could earn income from it. Simply charging fees for the services is an easy way to solve that. After that, start telling all of your friends and family what you are doing, ask for their support to start getting clients. Marketing and Networking should be a completely different post, and it will be, but for now, get a book on it, there are thousands out there. Market to your hearts content, it will take a little work, but the rewards are fantastic.

Once you’ve starting seeking clients, and there is a very good potential you will start to earn income, THEN you can start thinking about everything I wrote about above. Do not worry about any of that until you have the very likely potential to start earning a fair amount of income.

First and foremost, most people think you need a fictitious business name. This is a myth, as long as the business name you choose has your last name in it, you don’t need to go through the ridiculous steps of getting one. For those of you who think that you need to have a catchy business name, you don’t, it makes no difference whatsoever what you business name is. When you start pulling in over $100k a year, then you can start thinking about branding your name.

As far as Corporations, LLC, S-corps, I find that way too many people place way too much emphasis on this. It really doesn’t matter if you are grossing less than $30k per year. The liability protection that you get from a corporation is only worth it when you start making larger sales, and making more. Typical businesses follow UCC and contract law, both of which have strict limitations regarding suing for punitive damages. Only when you run something like a daycare or dog walking service will you NEED insurance to cover you, insurance policies are cheap and will cover an extraordinary amount in the instance of a tort. Besides, you will need to have insurance anyway once you start making money.

So in summary, simply put, dont worry about corporations until you gross more than $30k a year. The true upside to corporations is the income shifting effect to help lower taxes, I will go over this in a future post.

Once you have a very good potential to make money, you will also need to consider licenses and permits. I know I will regret saying this, but business licenses were truly meant for retail establishments, cities extended this to incorporate everyone  even considering starting a business as a means to generate more revenue, but how many times would someone buying something off of your website ask if you have a business license? Thats right, never. So until you gross $30k a year, or open a retail operation, then you can think about a business license.

You absolutely must get a license (and or permit) for child care if you do that, I’ve heard its easy to do though.

OK, so after all of that, you should have a business going, open a seperate checking account for the business and use that to charge expenses related to the business! This is the ULTIMATE way of lowering your tax bill. A business is the only way to write off nearly 100% of your expenses, no W2 job allows you to do that.

Once you really start to make money, income shifting, S-corp pass through, and capital gains, and tax credits come into effect which reduce taxes even more!

Example for my family and I: My wife likes horses, and spends a lot of money on them, we decided to start a business breeding horses, we can technically take a loss for up to five years (because of IRS code on horse breeding). AND we get to have baby horses, how awesome is that!

Why it replaces a 401K:

Similar to a 401k, all of the expenses that you have on your business is fully tax deductible, and it is investing into the future earnings potential of the business, thus giving you a return on investment. Unlike wall street, which has ups and downs that you cannot control, your business is in your control and you can single-handedly create 100% returns on your investment. This is simply an alternative way to view saving for retirement.