Catch Up On Some Tax Planning

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Anytime is a good time to improve tax fitness with a few simple exercises.

Consider Roth IRA assets. By keeping assets inside a Roth IRA, they can grow tax free for retirement. Also, this year people can convert traditional IRAs to Roth IRAs. Account holders are no longer subject to the $100,000 modified adjusted gross income limit. With conversions that occur in 2010, they can also split their conversion amounts equally and report them as income for tax years 2011 and 2012.

Take advantage of tax-deferred retirement accounts. If you have a 401(k) or other employer-sponsored retirement plan available, contribute as much as you can afford to contribute. By increasing contributions every time you get a raise, you can increase your savings. The plans are basically funded with pretax dollars, which will reduce taxable income. Also, that money will grow tax free until it is withdrawn. If the contribution is to a Roth IRA, it is made with post-tax money, so the funds can be withdrawn tax free after the age of 59½.

Consider a 529 college savings plan. The annual $13,000 gift would go a long way toward the amount needed to save for education expenses. Contributors may also be eligible for a state tax deduction or credit. They can also take advantage of a special five-year accelerated gifting provision, which is $65,000 in one year per contributor. That covers the current year and the next four years.

Hold assets more than a year. Any capital gain made within a year is considered taxable income, like a salary. But gains taken after a year are considered capital gains, which in 2010 is taxed at the maximum rate of 15 percent. The capital gains rate is almost always lower than the income tax rate. Also, the capital gains rate is expected to go up to 20 percent next year, so some people are taking advantage by taking their gains this year.

Give to charity. Contributing to charities is always a good idea. But if you are planning a gift, it might be best to do it soon, because some in Washington have been looking at cutting back on charitable deductions as a revenue-saving measure.

Thomas P. Marshall is President of Virginia Estate and Retirement Planning Advisors, Inc., a Fee-Based Richmond Financial Planner with offices throughout Virginia.

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Tax Credit Vs Tax Deduction

Tax Credit Vs Tax Deduction. Before we touch on their differences, let us discuss about what they actually are. In a nutshell, both tax deduction and tax credit have similar effects:  basically, they reduce the amount of the tax owed to the IRS (Internal Revenue service.).Tax credit and tax deduction differ in various ways. They differ in the way they are calculated, the affect on the over all tax payable, filing and reporting, and the eligibility of the tax payers.

How Tax Credit and Tax Deduction affect tax reduction?

The amount of tax reduction is where the main difference of tax credit and tax deduction lies. Your taxes gets more reduction with a tax credit simply because it is directly subtracted from your taxes. It is also known as “below-the-line” item. Tax deduction on the other hand has a lesser effect on reducing your tax payable since it only affects your gross taxable income. Items included in a tax deduction are called above the line.

 

How Tax Credit and Tax Deduction are calculated and reported.

It is easy to calculate tax credit. Generally it is a percentage of an expense. While a tax deduction is calculated within your taxable income. Tax forms such as Retirement Savings Contribution are used for tax credit. Here you will need to make use of the IRS Form 8880 for you to get to claim the credit. For deductions, like the student loan interest deduction, one would use a worksheet to calculate the amount of reduction that would be applied to one’s taxable income.

In reporting both tax credit and tax deduction, one would use the IRS form 1040. Tax deductions are reported under Schedule A. Tax credits reports need more specific tax credit forms. Different kinds of tax credits will have to be filed under different forms. Unlike tax deductions where they all will be recorded in the Schedule A form.

Who qualifies for tax credits or tax deductions?

There are different kinds of tax credits. The eligibility for a person will depend on the tax credit stipulation.Take for example the tax credit for first time home buyers. Single individuals who are making less than $95000 a year or married couples who are earning less than $150000 a year are eligible for the $8000 dollar first time home buyer tax credit. . This limit is usually based on one’s modified adjusted gross yearly income. And to claim the refund, the IRS form 8839 is required.

Tax deductions are not as complex. They usually cover standard expenses such as interests on debt or mortgages, accidents, casualty, loss incurred due to theft, expenses on education and many more. Unlike tax credit, almost every tax payer is eligible for tax deductions specific to their financial situation. Tax deductions are used to determine taxable income. Tax credits on the other hand are usually used by the government as stimulus programs. As used in the example above, the $8000 first time home buyers is one of the programs of the government to help more people acquire their very own homes especially in times like now where so many people are facing foreclosure on their properties.

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Laffer Curve: Explaining taxation, theoretically

The Laffer Curve is an graphic representation of the theory of Taxable Income Elasticity. First proposed by Jude Wanniski in the 1970s, the Laffer Curve is named after Arther Laffer, a supply-side economist who Wanniski based his work on. Everyone else’s translation: The Laffer curve shoes what the government is able to charge in tax debt before revenue begins going down.

The math behind the Laffer Curve

For those of us who don’t have degrees in math or theoretical economics, here is how the Laffer Curve works. Taxpayers will change their behavior based off of taxes is what the theory of economics states. When the government doesn’t tax, the people are more likely to earn as much money as they can while they government gets nothing. At 100 percent tax, the government will also receive no money, because there is no motivation for taxpayers to earn money. This means that the tax rate needs to stay between 0 and 100 percent. On the Laffer Curve this is usually somewhere around 50 percent even though that wouldn’t be the ideal tax rate. Some studies have put the ideal tax rate at anywhere between 30 and 40 percent

The Laffer Curve affecting US policy

The Laffer Curve was first proposed in the 1970s. The underlying theory is, however, used by US tax policies often. Andrew Mellon made the argument that lowering the tax rate would bring in more money in 1924. The top income tax bracket was reduced from 73 percent to 24 percent between 1921 and 1929. In that same time period, income tax receipts rose from $ 719 million to $ 1 billion. The Laffer Curve theory was changed by the Regonimics in the 1980s and the tax cuts implemented by Bush in the 2000s.

Arguments against the Laffer curve working

The Laffer curve doesn’t exist in an economic bubble like most economic theories. Income tax is only supposed to be like a small loan to the government from the taxpayers to make sure of the economy of scale. Many historians point out that at near-100 percent tax rates, countries such as Russia were able to maintain a productive economy. Progressive taxation will make it much more complicated to get calculations from the Laffer Curve.

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Your Tax Bracket Finding your tax bracket, and understanding it

• 2009 tax rate schedules (returns filed in 2010)
• 2008 tax rate schedules (returns filed in 2009)
• 2007 tax rate schedules (returns filed in 2008)

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Your tax bracket can be used to estimate the amount of additional tax you’ll pay if your income increases — or the amount you’ll save if you can claim a deduction. If you’re in the 25% tax bracket you can expect to pay about $250 additional tax if you have $1,000 additional taxable income. In the 15% tax bracket, a $200 deduction will save you about $30. Knowing your tax bracket can help you make better tax planning decisions.

Where tax brackets come from

Congress establishes tax rates that apply to different levels of taxable income. Current law provides rates from 10% to 35%. The higher your income, the higher your tax rate.

The range of income where you stay at any particular rate is known as a tax bracket. For a single person in 2008 the rate on taxable income between $32,550 and $78,850 is 25%, so those numbers establish the 25% bracket. If you’re single and your taxable income is between those two numbers, your tax bracket is 25%.

Frequently asked

Here are some of the most frequently asked questions about tax brackets.

• Is my tax bracket established by the amount I earn on the job?
  Some people have in mind the general notion that their tax bracket depends on how much they earn as an employee and won’t be affected by other kinds of income. In reality your tax bracket depends on your taxable income, regardless of the source of that income. For example, you can move into a higher tax bracket because of increased interest income or a distribution from a pension plan — or even because of a decrease in your deductions.
• Will capital gain or dividend income push my other income into a higher tax bracket?
  No, the tax rates apply first to your “ordinary income” (income from sources other than long-term capital gains or qualifying dividends) so these items that are taxed at special rates won’t push your other income into a higher tax bracket.
• If my ordinary income puts me in the 15% tax bracket, can I receive an unlimited amount of long-term capital gain at the 0% rate?
  No, the 0% rate applies only to the amount of long-term capital gain and dividend income needed to “fill up” the 15% tax bracket. For example, if your ordinary income is $4,000 below the figure that would put you in the 25% bracket and you have a $10,000 long-term capital gain, you’ll pay 0% on $4,000 of your capital gain and 15% on the rest.
• Will my overall tax go up sharply when my income reaches the point where I’m in the next tax bracket?
  No, there’s no reason to be concerned about this possibility. When you reach a higher tax bracket, any additional income will be taxed at the higher rate, but the income required to reach that level is still taxed at the lower rates. For example, if your taxable income is just $100 above the limit on the 15% bracket, the last $100 dollars will fall in the 25% bracket and will cause your tax to increase by $25, but won’t affect the tax you pay on all your other income.
• Can I determine my tax bracket by looking at the withholding rate on my paystub?
  No, Withholding rates are based on averages, not specific tax brackets. For example, your withholding rate may be about 20%, even though there’s no tax bracket between 15% and 25%.

• Are tax brackets the same as marginal rates?
  Not exactly. In some cases the added tax you pay when your income goes up isn’t the same as your tax bracket. That’s because the added income can cause you to lose some other tax benefit. For example, added income can mean smaller itemized deductions or a reduction in the amount you claim for your exemptions. You may find that $1,000 of added income causes your tax to go up by $292 even though you’re in the 28% bracket. Your tax bracket is just an approximation of the added tax. To be more precise, we would say you have an effective marginal rate of 29.2%. In most cases, the tax bracket is close enough to the effective marginal rate for purposes of tax planning.

Finding your tax bracket

Finding your tax bracket involves two steps. First, determine your taxable income for the relevant year. Then look that number up in the relevant tax rate schedule.

Tip: If you use tax software to prepare your returns, check to see if it will generate a report that includes information about your tax bracket.

Taxable Income

You can find your taxable income for a previous year by looking at your tax return. It’s clearly labeled — but not very conspicuous. Just look for the words “taxable income.”

If you need to estimate your taxable income for a year in the future, usually the best way to start is to know your taxable income for the most recent year. Then make adjustments for changes you might anticipate: increases or decreases in income or deductions, and perhaps a change in filing status.

Tax Rate Schedules

Once you know your taxable income and filing status, you need to look it up in the appropriate tax rate schedule. This is not the same as the tax tablesyou use to look up your tax! Those tables give you dollar amounts but not tax rates. What you want is a schedule that tells you the tax rate as a percentage for your level of taxable income.

The IRS publishes tax rate schedules in the instructions for Form 1040, and also for 1040-ES (the form used to pay estimated tax) — but not in the instructions for Forms 1040A or 1040EZ. Current tax rate schedules for every filing status can be found by calling our firm (877) 530-6505 .

Here’s a sample tax rate schedule: the 2008 tax rate schedule for single filers.

Single
Taxable income is over	But not over	The tax is	Plus	Of the amount over
$0	8,025	$0.00	10%	$0
8,025	32,550	802.50	15%	8,025
32,550	78,850	4,481.25	25%	32,550
78,850	164,550	16,056.25	28%	78,850
164,550	357,700	40,052.25	33%	164,550
357,700		103,791.75	35%	357,700

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