With 2017 tax rates ranging from 10% for those in the lowest tax bracket to a high of 39.6% for the highest wage earners, income taxes amount to a huge “expense” for most American taxpayers. A wage earner with a $50000 income, which is somewhere in the middle of the 25% tax bracket, can expect to pay over $12000 in federal income taxes alone! This being the case, it is important for individuals to be aware of the many ways available to save tax dollars and, on the flip side, to carefully avoid the pitfalls that can result in paying taxes in excess of what would otherwise be owed.
One of the easiest ways to save tax dollars is to take advantage of tax credits and tax deductions offered by the IRS and various state tax agencies. A tax credit offers a dollar for dollar reduction in the tax amount owed while a tax deduction reduces taxes by a certain percentage, normally determined by the marginal tax rate for that particular taxpayer. Available tax credits, which vary from year to year, are available for such things as child care costs, education expenses, caring for elderly or disabled family members and various energy saving improvements, among other things. Deductions include the standard deduction as well as numerous others including charitable contributions, medical expenses, tax preparer and financial adviser fees and unreimbursed employee expenses, to name only a few. Although they operate differently, both tax credits and tax deductions are valuable tax breaks that can provide taxpayers who know how to use them effectively with significant tax savings.
A second major tax saving opportunity is to make use of effective tax planning strategies. Many components of the tax system are time sensitive, thus making it possible to save tax dollars simply by adjusting the timing of certain tax related decisions. Some of the many tax considerations that are particularly affected by timing are the sale of investment properties and other investment assets, Roth conversions, gifting and 401(k) and IRA distributions. Timing can also be used to shield capital gains from taxation by pairing them with capital losses or using any one of a number of advanced tax planning strategies such as a 1031 Exchange or a zero cash investment transaction. Tax planning is also important for businesses and includes such considerations as buy-sell agreements, family succession transfers, captive insurance plans and defined benefit and contribution plans, among many others.
A third and final way to save valuable tax dollars is to meet tax filing and tax payment deadlines in order to avoid the penalties and interest associated with the late filing of a tax return and the late payment of taxes due. Failure to File and Failure to Pay Penalties are charged for each month or partial month that a return is late or that a back tax balance is owed. The penalty rate for Failure to File is 5% of the outstanding tax liability up to a maximum of 25% of the tax amount owed. Failure to Pay Penalties are assessed at a rate of 0.5% of the back tax balance with no ceiling on the amount that can be charged. Together with the interest that is assessed on any overdue tax balance, these penalties compound over time and can add a significant additional tax burden that is easily avoided by following the IRS guidelines.
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