Personal Tax Deductions

Personal Tax Deductions – Special Report

Personal Tax Deductions: Are you taking all that you're entitled to?

INTRODUCTION

It's tax time again! Our one hope and wish is that we don't owe the Internal Revenue Service the life of our firstborn child. In our fear of a tax bill, we overlook the fact that a tax bill is not the primary consideration when it comes to filing our income tax forms.

Do you know that most people find the simplest way to file their taxes for the sake of expediency? On the surface, this seems harmless, but they could be paying more in taxes than they have to. These filers could also be receiving only a percentage of the tax refund that they are entitled to under the tax laws.

The question is: Are you receiving the full tax refund that you are entitled to? Exploring the world of personal tax deductions opens the door to a myriad of deductions that are often overlooked by the everyday tax filer. It's time to correct that mistake and receive a bigger refund or at the least, a much lower tax bill this year.

In this report we will discuss:

* Tax Basics: What do you need to know to plan ahead for tax success?
* Tax Forms: Which one do I fill out and when?
* Tax Terms: What does all that jargon mean?
* Deductions: Standard or Itemized?
* Tax Credits: Which do I qualify for?
* Commonly Missed Deductions
* New Tax Laws

The mere thought of taxes makes our heads spin. It seems daunting but the information in this report can provide you with the knowledge to become tax savvy when it comes to your personal tax deductions.

TAX BASICS

Planning Ahead

The quest for a higher tax refund begins not at tax time but the first day of the new tax year. The earlier you start, the more financial options you can put into play. But, if it's the middle of the year, all hope is not lost. There are still things you can do to reduce your tax bill.

The W-4 Decision

On the first day of any job your human resource manager will hand you a stack of forms and ask you to fill them out. Pay special attention to the W-4 form. This is the tax withholding allowance form. For state and federal tax purposes, you have the option of claiming exemptions that affect the amount of money taken from your paycheck for each.

The form allows you to claim a certain amount of withholding through your dependents. This includes you. You can claim yourself as a dependent along with your spouse, children, and any other people living within or outside of your household that qualify as dependents according to the IRS. Each dependent is equal to a certain amount of tax dollars to be withheld.

Withholding allowances can also be claimed for other purposes. Tax credits garner withholding allowances. If you expect to receive any money from tax credits claimed on the tax return you can have money withheld against that amount. These credits include child care credit, child tax credit, earned income credit, education credits, and foreign tax credits.

Are you planning to itemize? It might be a good idea to claim a withholding allowance for these future deductions. Medical expenses are just that-expensive. Having more money in your pocket in anticipation of these out-of-pocket expenses can be recouped at the end of the year.

The purpose of withholding allowances is to avoid paying a hefty tax bill while putting more money in your pocket during the year. An income tax table can help to determine how much tax you should be paying for state and federal depending on the yearly salary. An ideal situation would be to break even and owe no taxes to the IRS based on your taxable income. Any deductions, exemptions, or tax credits over and above that would result in a refund to you.

IRA Contributions

Money set aside in retirement vehicles can reduce your tax bill by reducing your taxable income at the end of the year. Employees that take advantage of an employer-sponsored retirement plan benefit from the deferred tax dollars being deducted each pay period. Monies invested in these plans are tax free until the time that the money is withdrawn from the account.

Invest the maximum amount that the company allows if you can afford it. The more money that is deferred, the better off your bottom line will look at tax time. Besides, the company matches the funds up to a certain amount and that will increase your retirement funds available when you need them.

Company sponsored retirement plans are not the only ones that can be used to reduce your taxable income. IRA's opened through other financial institutions also qualify. People who are self-employed can use these retirement funds as a way to reduce the amount of taxable income. For most of these funds if not all, the money is not taxed until it is distributed.

Educational Plans

The cost of higher education is increasing each year. By the time your toddler goes to school, you could be spending as much as $100,000 for their education. Parents offset this future college bill by putting money into educational plans.

These savings plans earn interest for college. Some plans like the 529 are education accounts that invest the money to increase the return. Parents and other family members can contribute up to the yearly limit to ensure that there is money available for college. Where these plans fall short, the government offers tax credits to offset qualified expenses over and above for educational purposes. Better still is the fact that it is not only your children that benefit. You can go back to school and claim educational tax credits for money spent.

Documentation

Documentation is important when it comes to taxes. No one wants to be audited, but it could happen if the IRS draws your return from a random audit. Set your mind to keep any and all receipts that pertain to tax credits, deductions, or exemptions you want to claim on your income taxes for the filing year.

The guy with the shoe box had the right idea. The documents are easier to locate if you keep them in separate files but the point is to keep any receipts that could benefit you later. This is an excellent idea for filers that plan to itemize their deductions.

Several itemized deductions have a limit. This means that unless your expenses exceed a certain dollar amount, you will not qualify to itemize for that particular deduction. Records of charitable contributions, medical, health, and business expenses give you an idea of whether or not you will incur enough expenses.

Do you have a home business? The area that serves as your office could be tax deductible. As such you will also be able to deduct a certain portion of the utility bills for the year. Keeping a record of the total amount of each utility paid makes the calculations easier.

Filing Status

How will you identify yourself this year? There are five filing statuses: Single, Married Filing Jointly, Married Filing Separately, Head of Household, and Qualified Widow(er) with a Dependent Child. Filers may qualify to list under more than one status, but the benefits of each are not the same.

Choosing the proper filing status is important. The amount of taxes an individual is required to pay depends on filing status. It determines your tax rate. The standard deduction that can be claimed on your tax return varies by status. Certain tax credits are not eligible if filing under a particular status. If that tax credit is important to your tax bill, another status needs to be chosen.

Filing as Single is designed for unmarried or divorced individuals. The tax rate is highest for single filers. The standard deduction for a single filer is around $5,150. If you file under this status make sure that you don't qualify for any of the others.

Filing as Married Filing Jointly is designated for married couples. The standard deduction is highest for this category. Married filers can claim a $10,300 standard deduction. Married couples also have the option of filing separate tax returns if the benefit is better.

Filing as Head of Household can be used by a single filer with qualifying dependents. You will have to have provided for at least all of the expenses for yourself and that child for half a year or more. Single parents don't have to settle for a Single filing status when Head of Household will bring them more of a standard deduction. The standard deduction for Head of Household is $7,550.

Married Filing Separately can be used by married couples that would benefit more from filing separate returns. The tax rate here is almost as high as a singe filer. It should be noted that married filers that file separately cannot claim the earned income credit if they qualify.

A Qualified Widow(er) with a Dependent Child gives a tax break to people who have lost a spouse. To qualify, they have to not get remarried in that same year. The dependent has to live with and be provided for by the widow or widower the majority of the year for which they are filing. The standard deduction here is $10,300. A person who has lost a spouse can claim this status for up to two years after their death.

Tax Forms

Tax filers will complete a standard tax form called the 1040 Form. The 1040 has more than one version and the one filed depends on income, deductions, and miscellaneous taxable income. To fill out the 1040 form the taxpayer gathers information form several other tax document forms that are received through the mail. Some forms you may recognize like the W-2, but others may look foreign to you such as the 1099 forms and the 1098. There are a lot of numbers floating around but it is not hard to figure out.

After the first of the year, look for your tax book to come in the mail. This will be the 1040 form that you have filled out in previous years. Other tax forms can be downloaded and printed from the IRS website. The forms here will be in the form of a PDF file so Adobe Acrobat Reader is needed. A free version of Acrobat Reader can be downloaded from the Internet and run on your computer. The post office generally carries copies of current tax forms also.

The 1040 Forms

The standard 1040 form has the most items of all the 1040 forms. All deductions, credits, expenses, and income sources can use this form to file. Self-employed individuals need to use this form to file their tax return. Because the 1040 form has so many items it can also be the most confusing. If you make over $100,000 in income or itemize your deductions, this is the form for you.

The 1040EZ is the simplest of the 1040 forms. People that are not itemizing and have no other complicated deductions can use this form to file as long as their income is under $100,000. Individuals claiming the earned income credit can file using this form. Single filers and married filing jointly both without dependents can file their taxes using the 1040EZ. Since this form is very limited except for the basic tax filer, most taxpayers use one of the other forms.

The 1040A form applies to all of the five tax filing statuses. The income of the taxpayers in this category is below $100,000. Tax credits that you may qualify for can be claimed on a 1040A form. Dependent exemptions can also be claimed here as well.

Miscellaneous Forms to File

There are other tax forms that can be filed with the 1040 forms if you have special circumstances. These forms generally have to be filed at the same time to receive the exemption, credit, or other benefit that they provide.

The 1040ES form is a voucher used by businesses to pay their tax bill. The tax bill is played quarterly to avoid a large one time payment at tax time. Self-employed individuals, those receiving an inheritance, and those who have made money in the stock market can use this form.

A 1040X form is an amendment form. If you forgot to record some income on your normal tax form or you want to change the tax filing status you can use this form to do it. The only thing not permitted is to change your filing status from joint to filing separately if you are married. A taxpayer that realizes it is better not to itemize can decide to claim the standard deduction here.

Do you need more time to get your taxes together? There is a form for that. Form 4868 is an extension that gives a filer six more months to file their return after the tax due date. For your convenience, this form can be submitted via the telephone or on the Internet.

Schedule SE and Schedule C are tax forms used for freelance workers. Freelance workers need to claim the money that they have received over the course of the year. The Schedule SE is for freelancers that make over $400. It is used to determine how much you will owe in taxes. As a business of one, you are considered to be employer and employee and are required to pay taxes for both. Schedule C is for businesses with more than $5,000 worth of expenses to claim.

Tax Forms you may Receive

There will be plenty of tax documents coming in the mail from various sources. It's important to recognize what they are so they don't get thrown away by accident. The one everyone wants to see first is the W-2 document from your job.

Each employer will send you this form. It details the exemptions you specified on the W-4 form when you started work and the amount of total taxes deducted. You'll receive a copy for your records and to file with each income tax form.

The 1099 forms report miscellaneous income you have received. 1099-MISC is for any money you received for freelance work. Earnings over a few hundred dollars have to be reported by an employer that contracted you to do work for them.

1099-DIV is for reporting dividends from investments. 1099-INT forms come from banking institutions reporting interest earned on your money. 1098 is the form that comes from the mortgage company showing any interest you paid throughout the year.

Important Tax Terms

We would have a better chance of figuring out our tax returns if we just understood the lingo. Tax terms sound like Greek to most people who aren't used to dealing with taxes on a regular basis. Here are a few terms that most people want to understand better.

1. Deductions-Expenses that the IRS allows you to subtract from your taxable income are called deductions. This includes standard or itemized deductions and any deductions that you can claim for each dependent. Interest paid can also be deducted on your tax return.

2. Credits-Credits are benefits qualified for from the federal government that reduce the amount of your tax bill. Credits are better than deductions because they lower the bottom line instead of just the amount of taxable income. A smaller credit can be worth the same as a deduction for three times that amount. Credits exist for child and dependent care, earned income credit, and educational expenses to name a few.

3. Taxable income-This is the amount of income that the IRS uses to determine your taxes. When the W-2 shows that you made $40,000 in taxable income for the year, this amount can be reduced further through personal deductions and/or exemptions.

4. Standard deduction-The standard deduction is figured out by the IRS and set down for each tax filing status. Taxpayers have the option of taking the standard deduction or itemizing their deductions for a bigger tax break.

5. Itemized deductions-A taxpayer can choose to add up the total of their qualified expenses for medical, business, hobby, and charitable contributions instead of taking the standard deduction. Itemized deductions have certain limits for each so they should be read carefully.

6. Exemption-An exemption is money that the government deducts from your income based on the people listed on your tax return that benefit from your income. Exemptions can be claimed based on anticipated credits and business expenses.

7. Dependents-A qualifying dependent is anyone who is related by blood or marriage that you provide at least fifty percent support for. Except for your children, the person cannot claim themselves on a tax return. Dependents must be under the age of 24 and can't be claimed by another on a tax return. Lastly, a dependent has to be a United States citizen, or resident of Canada, Mexico, or the U.S.

DEDUCTIONS

What deductions can you claim? Will you use the standard deduction or itemized deductions? Deductions lower the taxable income that Uncle Sam can bill you for. Every year new deductions are introduced but most are not claimed by the masses because they don't know that they qualify for them.

Standard Deductions

The government decides on an amount for the standard deduction each year. The deduction is based on the filing status of the individual or individuals filing out the tax return. Taxpayers can opt to take the standard deduction or itemize if they feel that they have enough qualifying expenses. Filers that fit into more than one tax category can choose the one with the higher standard deduction to lower their tax bill.

Single $5,150
Married Filing Separately $5,150
Married Filing Jointly $10,300
Qualified Widow(er) with Dependent Child $10,300
Head of Household $7,550

Itemized Deductions

Itemized deductions fall into certain categories: Health care expenses, job-related expenses, charitable contributions, casualty or theft, taxes, and interest. Check over each of the categories to see if you have any expenses that qualify you for itemization. This is also an excellent guide for planning deductions for the coming year.

1. Health and medical expenses-There is a threshold limit on the expenses in this category. Expenses claimed must be more than 7.5% of the adjusted gross income of the taxpayer. What qualifies in this category? Traveling back and forth to the doctor for yourself or another dependent family member, home improvements for a disabled dependent, glasses, contact lenses, dental visits, medical procedures-all of these situations can incur qualifying expenses. If you have a flexible spending account with your employer, this money cannot be counted because no tax was ever paid on it. Keeping all of your receipts will give you make it easier to recall all of the expenses you have paid for out of your pocket.

2. Job expenses-Who doesn't want to better themselves and get promoted. Professionals who belong to organizations pertaining to their careers or invest in publications for continuing education can claim these expenses as itemized deductions. Uniforms for jobs like restaurants and grocery stores have to be maintained by the employee. Your laundry bill is a deduction. If you have to purchase your own uniforms, that is also a deduction. Traveling to conferences, meals, and accommodations are subject to an itemized deduction. Be careful of the threshold though. The total expenses have to exceed 2% of the adjusted gross income.

3. Charitable contributions-If you are claiming monies that you have given to charity, the laws will be stricter next year. Contributions have to be in good condition and a receipt received from the charity as to the assessed amount of the item. Credit is given for non-cash contributions according to their value at the time not what was paid for them by you. If you give away a car or paintings, your receipt will reflect the current value. The limit on this one is lower than 50% of the adjusted gross income. For any item that would have incurred a capital gains tax, the cap is lower than 30%.

4. Casualty and theft losses-Was your home broken into? Did a natural disaster wipe out your residence? You way qualify to deduct the amount of that loss. The total loss amount has to exceed 10% of your adjusted gross income. In addition, there is a $100 amount subtracted for each occurrence of theft or loss.

5. Sales tax-State taxes can be deducted on a tax return. Taxes that were levied on your personal property based on value can qualify for itemized deduction. This also includes sales tax, but if the state that you live in collects both sales tax and income tax, you have to choose between the two for your tax return.

6. Interest-Interest paid on mortgages and loans can be itemized as well. Rental property counts in this deduction.

Tax Credits

If we discuss tax deductions we also have to say a bit about tax credits. Credits actually benefit the taxpayer more than deductions. This is by no means to say that you should ignore deductions. Both of them can be claimed on a tax return so find as many of both as you can.

1. Earned Income Tax Credit (EIC)-There is a lot of misinformation about this tax credit. Most of the taxpayers that claim it have dependents on their tax return, but dependents are not necessary to claim the credit. Single filers can qualify for the earned income tax credit. This tax credit was introduced to help low-income working families keep more of the money that they make in their pockets and out of Uncle Sam's. Depending on the number of dependents, filers can receive as little as $400 or as much as $4,500. There are income limits for a single, one child, and multiple child filers. Married couples that qualify for the credit get to add another $2,000 to the salary cap to account for the other spouse. Children that are claimed must meet the IRS' definition of a dependent child.

2. Child and Dependent Care Credit-Children under the age of 13 can qualify a parent or guardian to claim the child care tax credit. Expenses for the qualifying child do not include anything paid using money from a dependent care spending account since the money was never taxed. For one child, a taxpayer can have up to $3,000 worth of expenses and double that for more than one child. Dependent care includes elder care expenses for a parent or other relative that cannot care for themselves and also lives in your residence.

3. Lifetime Learning Credit-This is one of the educational credits that give parents a break on college costs. The credit can be claimed at the rate of 20% of $10,000 or less of qualified expenses. Qualified expenses do not include books or room and board. Those paying a pretty penny in tuition can get up to $2,000 a year in credit.

4. Hope Credit-The Hope credit is another way for parents to see some of the money that they have spent on tuition and fees for their children. The credit is available for the first two years of college. This applies to a two or four year college program. The student has to be enrolled at least half time to qualify. Credits are claimed for 100% of the first $1,100 and only 50% of the next $1,100.

5. Coverdell Education Savings Account-This account functions like an investment account for educational purposes. Money can be contributed to one of these accounts for a student by any family member. As much as $2,000 can be contributed each year. The money can be used a variety of expenses including books, room and board, tuition, and fees. The money is used on a tax free basis. Taxes come into play on this money if it is not fully used by the time the student reaches age thirty. The funds are then subject to a 10% penalty. Penalties can be avoided by rolling the funds over into an account for another child. If the money used in any calendar year maintains its tax free status, the parents cannot claim the Lifetime Learning Credit or the Hope Credit for that tax year.

Commonly Missed Deductions

We are so bombarded with information that our brains begin to slacken after a while. It is normal to miss a few deductions due to the brain drain. Here are some of the more common deductions that people don't think about claiming but could further reduce their taxable income and result in a refund.

1. State sales tax-A sales tax is deductible. Actually all sales tax charged by the state on items you purchase is deductible. Most people miss this one because they live in a state that collects income tax. That simply means that the state requires a state tax return be filed by its residents. For states without an income tax, the state tax deductible can greatly reduce their tax bill. States with both force residents to choose and most choose the state deductible over the sales tax.

2. Educator expenses-Teachers and other educators can deduct as much as $250 for items that they purchase out of pocket for their classrooms. In places where educational money is limited, this is incentive for teachers.

3. 401(k) and IRA contributions-These are two ways to save for retirement and lower your taxable income. At the least an employee should contribute up to the maximum that an employer will match. Any money that is placed in one of these accounts is on a pre-tax basis and those taxes are deferred until distribution. The more tax free money shifted to these accounts the better it is for you when calculating taxable income.

4. Student loan interest-Are you paying back student loans? Here's some good news. You can deduct the amount of the interest that you have paid all year long. A qualified student can deduct as much as $2,500 per year until the loan is completely paid off. There are some restrictions. Taxpayers that make over a certain income per year are not allowed to receive this deduction. Those amounts are over $65,000 for single and $135,000 for married filers.

5. Home office deductions-Do you run a business from your home? You can deduct the cost of doing business there. A portion of all of the household bills can be deducted for the use of a room in your home as an office. A person with a home office can deduct for equipment and furnishings if they are used exclusively for the business and do not leave the room.

NEW TAX LAWS

There are new laws and amendments each year. Some don't apply to the everyday taxpayer but not and then there will be a few good ones that benefit us with deductions or credits. Here are a few. A detailed list can be found at www.bankrate.com under the heading 2007 Tax Guide.

1. Telephone tax credit-The government is going to help us out. Did you notice all of those taxes and fees on your telephone bill? The IRS has decided not to charge their federal excise tax anymore. As such, taxpayers can get a little back in the form of a tax credit. If you paid this tax from February 2003 through August 2006, you are due some money. The refund is on a per exemption basis. For one exemption: $30, for two: $40, for three: $50, and for four or more: $60.

2. Direct deposit options-It used to be that you could have your refund direct deposited but to only one account. It has been decided that tax filers can specify up to three separate accounts to divide their refund between. Form 8888 will take care of the transaction details.

3. Energy saving tax credits-Protect your environment and increase the efficiency of your home. Homeowners that have made home improvements to make their home more energy efficient can receive a credit. When they fill out the 1040 form they must also submit a Form 5695 to list the improvements.

4. Charitable donations-Donation rules will be stiffer in years to come. The items donated must be of good quality and in good condition or the donation will not count towards a deduction. For monetary gifts, the charity must give a letter to the donator acknowledging the gift and the particulars of the transaction. In lieu of that, a bank record is sufficient.

CONCLUSION

The world of taxes is a complicated one. There are rules and exceptions for just about everything. Despite all of that, the place where money is lost by taxpayers is in the deductions. Deductions exist for practically everything. If you are not sure if something is deductible, consult a tax professional. The last thing anyone wants to do is miss out on money that could have been theirs.

Stay organized. Keeping track of receipts, bank records, payment documents, and donation acknowledgements pay off in the long run. Where a deduction can't help, try a tax credit. Qualifying for tax credits reduces the tax bill as the deductions are reducing the taxable income. The result: a bigger refund. Get the money that you are entitled to from the IRS.