As 2009 is quickly coming to an end, many taxpayers are looking for opportunities to minimize the money they will owe the IRS. Considering the numerous taxpayer-friendly legislation implemented this year, I encourage you to assess your prospective tax situation (if you have not already done so) and consider some year-end tax planning.
Here’s a review of the tax basics to help you understand the big picture of your tax liability. Simply stated, these are the steps the IRS will go through (in a not so simplified manner) to figure out how big of a check they should receive from you each year:
- How much money? The IRS wants to know ALL the money you (and your spouse) made/will make this year. This amount is called your GROSS INCOME (GI). For a lot of people, this can be easily determined by looking at a pay stub or your last year’s tax return. Unfortunately, this calculation can becomes more complicated for people who have their own business, invest, gamble, or have even sold a few things on ebay.
- Are you an above-the-liner? These are the first “layer” of deductions subtracted from your GI that typically stem from a business or profit related cost of producing income. Your gross income, reduced by these deductions, equal your ADJUSTED GROSS INCOME (AGI).
- What other deductions are you eligible for? Your AGI is reduced by your total “personal exemption” deductions, and the GREATER of either (1) your itemized deductions, OR (2) the standard deduction. The resulting number is your TAXABLE INCOME (TI).
- Status please. Before you can see what tax rate your income will be subject to, you must decide your “filing status. If you’ provide over 50% of the financial support for another person, you can file as a “Head of the Household.” However, if you’re single and the closest thing you have as a dependent is your pooch (which the IRS fails to consider a dependent) you must file as an “Unmarried Individual.” Finally, if you’re married, you can either file jointly or separately from your spouse.
- Tax time. Your TI is now multiplied by the appropriate tax rate for your filing status. The resulting figure is your “TENTATIVE TAX” (TT) owed.
- Count the credits. Any available credit(s) are then subtracted from your TT. Credits are typically much more valuable than deductions since they directly reduce -dollar for dollar- the amount of tax you owe. Some credits are refundable (such as the $8000 first-time home-buyer credit). This means that if you end up with a negative number when you subtract the credit from your TT, you’re one of the lucky people that will be receiving a check from the government (i.e. a tax refund).
- Get out your checkbook. The excess TT over the applicable credits is your “TAX LIABILITY.” This is the amount of money you will have to pay the IRS next April.
The good news is that you still have time to reduce (or even eliminate) the amount you will owe to the IRS.
Contact tax attorney Sarah Martello and further discuss your tax situation and receive advice regarding tax planning opportunities