How To Lose Debt

While it may be too soon in this blog to discuss the various ways to reduce your Federal tax burden, it can provide an avenue to reduce expenses in addition to increasing your wealth and income.

Benjamin Franklin once said, the only thing certain in this world is death and taxes.  As we have limited control over the first subject, we will move on to taxes. Let’s start with Federal income taxes.

Federal income taxes can be reduced in a number of ways.  One obvious way is if you don’t have federal taxable income, you don’t pay federal income taxes.  Now I do not know anyone that would resign their job, just to avoid paying federal income taxes, do you?

The only reason I noted it is that Capital Gains taxes, the tax on net gains from investments, is taxed at a much lower rate than income.

What this means is, if you are lucky enough to have a large nest egg to throw around into various investment vehicles, then you are going to be paying a lower rate of taxes on those capital gains.  Now mind you, with investments come risk, or else its considered income, like bank interest on a CD.  As a matter of fact, by IRS rules it must have risk to be considered an investment subject to capital gains tax.

A very smart teacher of mine once said, do you want to pay the IRS $100,000 per year in taxes, or do you want to pay the IRS $1,000,000 in taxes.  The correct answer is $1,000,000, because if you have to pay that much to the IRS, you must be making 10 times more than the person paying $100,000!

Banks are federally insured up to $250,000 per depositor now through the end of 2009, so theoretically there is no risk. It is backed by the full faith of the United States Government.  You are good with that, no?  Therefore, bank interest is considered income and is taxed at the regular income rate, which can be as high as 36% and growing.

One way to reduce your federal tax burden is to itemize your deductions. There are two constraining items:

1. You have to have allowable deductions larger than the standard deduction that they give people that don’t itemize, and,

2. You don’t fall into that quagmire of people making too much money where they begin to reduce the total amount of your deductions.

We will concentrate on item 1 first.  For 2008, you would need to have deductions of at least the amount shown below to benefit from itemizing, based on your filing status:

Filing Status                                        Minimum Allowable Deduction

Single                                                    $5,450
Married Filing Jointly                 $10,900
Head of Household                         $8,000
Married Filing Separately           $5,450

For item 2, if your adjusted gross income is more than $159,950 ($79,975 if you are married filing separately) then your deductions will begin to be phased out. This limit applies to all itemized deductions except medical and dental expenses (over 7.5% of your adjusted gross income), casualty and theft losses, gambling losses, investment interest and certain qualified cash contributions for relief efforts in a Midwestern disaster area! You simply can’t make this stuff up!!

On top of phase out of the amount you can deduct, there is also another crazy animal called the Alternate Minimum tax (AMT).  If you make too much, and your deductions are too high, then you pay what amounts to a penalty tax on top of all this other stuff.  It was originally put in place to capture the very rich who were evading taxes with large deductions, but since it was never indexed for inflation, it now impacts a large portion of the middle class in this country.

For more information on itemizing deductions, the AMT, and many other items, please see IRS Publication 17.

Also, see the IRS instructions about itemizing.

Now I would recommend if you are planning on itemizing your deductions for the first time, you either use a software program like Intuit’s Turbo Tax, or hire a professional accountant. There are even places that offer free tax filing assistance like the IRS’s Free Tax Return Preparation For You by Volunteers, and at certain colleges and charities.

Go for it, you just might reduce your Federal Tax burden!!