These handy tips will have you ready in time for April 15.
No one can be expected to understand everything there is to know about income taxes. That would be pretty impractical, being that the Internal Revenue Code is about five times longer than the Bible. However, there are some common-sense tips that will help the average taxpayer improve their financial situation and prevent unpleasant situations.
While it’s always great to obtain a tax refund around April, it may not be the greatest approach. A refund is simply receiving money back on the interest-free loan you presented the government more than one year ago. On the other side of the coin, owing a gigantic tax bill isn’t the wisest strategy either. Rather, the smart approach is to plan withholdings and other tax procedures to either receive a marginal refund or owe just a bit more in taxes after filing a return.
Audits are a worry rarely experienced by the majority of the population, with the IRS auditing only 1.03 percent of individual returns. High income is one of the biggest factors — only 0.9 percent of people with income less than $200,000 encountered an audit in 2011, but 12.1 percent of those who grossed at least $1 million did experience an audit. Specific business types also face heightened IRS inspection, including Subchapter S corporations and self-employed individuals who file Schedule C, with 4.3 percent of these returns audited. This high inspection rate is due to several types of deduction attempts that raise red flags with the IRS, including excessive moving expenses and medical deductions for unneeded cosmetic surgery — a staggering 69 percent of returns claiming the adoption credit were also audited last year.
Most small business deductions are a bit more complex than can be expounded upon in this brief overview, but this is a good synopsis of the basics. The self-employment tax refers to the employer portion of Medicare and Social Security taxes that business owners must pay. Everyone who works must pay these taxes, which are almost double the percentage of the average worker. Many people view the self-employment tax as discouraging entrepreneurship, but the IRS does a few things to lighten the load.
First, small business owners get to deduct half of their self-employment taxes from their net income. The IRS considers the self-employment tax a business expense and permits suitable deductions for it. Moreover, self-employment tax only incurs on net business income, or what’s left over after deducting business expenses.
Meals and entertainment are a joy for all, but also necessary in the business arena. To deduct these expenses, one must conduct business with an individual or group during an event, or immediately before or after it has taken place. These expenses are only 50 percent deductible. Examples of deductible expenses in this category include tickets to a sporting event, the cost of a meal or the cost of entry to a social affair. Be certain to keep scrupulous records of all business activity conducted: when, with whom and how it directly relates to the entertainment expense.
When using a car for local business trips or just going to and from work, the vehicle expenses are tax-deductible. Transportation costs are considered an audit flag, so be sure to only take what is permitted and keep excellent records. If people lease their cars for business, the entire lease payment can be deducted from the taxable income in certain instances. In some circumstances, the lease payment can be combined with individual deductions, such as operating costs.
The government is willing to subsidize retirement planning through Individual Retirement Accounts, 401(k)-style workplace programs and more, yet many people underutilize these benefits. The rules are intricate, especially for the different types of IRAs, but retirement accounts remain one of the best ways (along with diversification) to accrue wealth. However, there has been recent discussion of restricting tax benefits as the government deals with its own financial burdens. While retirement tax benefits might be in jeopardy, it’s best to take advantage of them while they’re still available.
As a business owner, I can state that the best way to reduce taxes is through owning a business. In fact, the government makes it easier to reduce tax liabilities for the small business owner. But the obligation is on the business owner to remain astute and vigilant in order to take advantage of every tax-saving opportunity that is offered through deductions, credits, depreciation and payroll-tax reductions.
5 Ways to Save Money on Taxes
1. Adjust your withholdings. Adjust withholdings on your W-2 to receive more income from your paycheck. Simply complete a new W-2 form with your employer, and you’ll have more cash in your pocket to pay down debt or save for retirement.
2. Donate to charitable causes. To earn tax deductions while helping those in need, consider donating goods that you no longer use. Keep a precise account of what you donate throughout the year. Any donation worth more than $250 will require a receipt, and there are limits to donating more than 20 percent of your adjusted gross income.
3. Save for retirement. Contributions to an employer-based 401(k) plan are made pre-tax. Depending on the specific circumstances and level of income, it is possible to write off what was contributed to a traditional IRA.
4. Go green. There is an assortment of green-energy tax credits available to the U.S. citizen. If you install alternative energy equipment in your home, it isn’t unusual to receive a tax credit for 30 percent of the cost of purchase and installation. Credits worth up to $7,500 for electric automobiles are also available.
5. Keep precise records. If your itemized deductions total more than the standard, you’ll receive a bigger return. To benefit from this option, accurate record-keeping is absolutely necessary. Items needed include, among other things, receipts and documents related to non-reimbursed job-related expenses, job search expenses, charitable donations and non-reimbursed medical expenses.