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The n00b's Guide to Tax Avoidance: 37 Surefire Tips
If you are reading this now, you probably belong to the nearly 70 percent of people who simply take a standard tax deduction without considering whether they would benefit from itemizing deductions. The truth is, most of us don't want to deal with the hassle of hiring an accountant or looking for our own deductions, so we just assume that taking the standard deduction will work out to about even. Thats a mistake. So to help you along, we have compiled a list of some of the best (and most under used) deductions available. Take note of the deductions you qualify for, and consider itemizing your taxes next year, because these deductions can really start to add up:
1. Clean Up Your Act: When preparing to pay taxes, most people spend a good 5-10 hours looking for receipts and trying to gather up the paperwork they have jammed in every 'junk drawer' throughout the house. But by that time, its usually too late to take any big deductions. The first key to tax avoidance is to just go out and spend the $6.99 to buy a file folder. Save all your receipts for everthing, even things you don't think you can deduct. Keep everything sorted into different categories. That way when you start looking into deductions (and there are always ones you didn't know about earlier) you will have the receipts to back up your expenses.
2. Keep Track: The second most important tip to keeping your tax liability to a minimum is to spend another $0.99 (I promise all these tips don't require you to spend money) on a legal pad. Every month when you pay your credit card bills, utilities, mortgage, etc. jot down all these expenses on your legal pad and throw it back in with your notes. Not only will this help you realize where all your money is going, but it will help you plan out your tax liability in a more strategic way rather than just throwing something together at the last minute.
Deductions On Property
3. Put it off a bit longer: A 1031 exchange is the best way to defer hefty taxes indefinitely. While you cannot eliminate these taxes, you can defer them. In a Section 1031 exchange, you don't pay taxes on the gain of a sale of a property if you reinvest the net proceeds in a similar or like-kind property. Quite a number of investors use this option to trade up on the value of their investments thus increasing income.
4. Property As Tax Saver: Property taxes also help you to claim major deductions. A big percentage of your monthly loan payment is tax. This amount goes into an escrow account for payment once a year. This amount is included in the annual statement you get from your lender, along with your loan interest information. These taxes will be an annual deduction as long as you own your home.
If you’ve just purchased your home, your share of the taxes for the year is fully deductible. Usually, when a property is transferred from the seller to you, the year's tax payments are divided so that each of you paid the taxes for that portion of the tax year during which you owned the home.
5. Repair & Save: Planning to conduct any improvements or repairs to your home? If you’ve taken a loan for this purpose remember, it is fully deductible in the year paid if certain requirements are met. For example, if you take out a new or additional loan to improve your principal residence (not your second residence), then the points you pay (and don't finance) can be fully deductible in the year paid.
6. Home Sweet Home: Buying a home is a huge expense and the mortgage loans can be quite heavy. However, your biggest tax break is reflected in the house payment you make each month. For most homeowners, the bulk of their mortgage payment goes toward interest. And all that interest is deductible – that is if your loan is less than $1 million. If you can afford a multimillion-dollar mortgaged home, the Internal Revenue Service doesn’t offer you too many sops – you can pay up.
7. Refinance to deduct: Did you refinance your home recently or maybe you went in for a home equity loan or line of credit. Either way, that interest is deductible. As a rule, equity debts of $100,000 or less are fully deductible. If you’ve taken an equity loan and are already paying off your first mortgage, your loan amount will end up being more than the property's actual value. In these cases, the IRS says you can deduct the smaller of interest on a $100,000 loan or your home's value less the amount of your existing mortgage.
8. Second Home Benefits: Are you comfortably placed to buy yourself a second home? If you answer is yes, then you’re in luck – the IRS favorably looks upon people who can invest more. Mortgage interest on second homes is fully deductible. Actually, if you don’t want a second home, you don’t have to buy one for the tax benefits only. You can always go in for a boat or RV – anything that has cooking, sleeping and bathroom facilities.
9. Sale Gains: Recently sold your home to move into a bigger one? Or probably you are planning to do so. Anyway, don’t forget to claim your deductions. When you sell a home up to $250,000 in sales gain ($500,000 for married joint filers) is tax-free. The only hitch is that you should have owned the property for five years and lived in it for two of the five years before the sale. If you belong to the military, you are excluded from the two-year use requirement (for up to 10 years).
You can qualify for the full exclusion whenever you must move to fulfill service commitments. The IRS does provide some tax relief if the sale is because of a change in the owner's health, employment or unforeseen circumstances. In these cases, the tax-free gain amount is prorated.
10. Keep The Stubs: It’s easy to wish that all those expenses on repairs to your home could be tax deductible. Sadly they’re not. But that doesn’t mean that you should throw the receipts straight away. Whenever you are ready to sell your home, you may find that your property has appreciated beyond the $250,000 ($500,000 for married couples) amount the IRS will let you keep tax-free when you sell. If that happens, the records of property improvements could help you establish a higher basis for your house and reduce your taxable profit.
11. Early Bird Gets Worms: Make early payments on your mortgage. You don’t have to make a habit of it but you could pay your January 1st mortgage payment on or before December 31st. This allows you to take an additional deduction for interest paid. Don’t forget to add the interest amount to the amount reported by your lender when they send you a 1098 form.
Tax Deductions For The Self-Employed
12. Save You Money With An Office: If you have a home office you can claim deductions on that. The deductions are irrespective of the whether you have a separate office facility or are using a portion of your basement or a converted den. You can deduct the percentage of your home used exclusively for business purposes. You can take this percentage off your mortgage or rent payments as well as your utilities. If you have a phone exclusively used for business, deduct those phone bills.
13. Deduct Business Expenses: Another thing you can claim exemptions on are business expenses. You must keep receipts and proper records of business travel and other expenses. This includes office supplies, postage and shipping costs, dues, subscriptions, and anything else business-related, including computer software for your business and upgrades to your system.
14. Childcare, Wow! Did you know that you could even deduct childcare costs? Deductions are allowed for daycare, nanny care, babysitting and any other type of childcare provided while you are working.
15. Plan for the future: Isn’t it time you start thinking about retirement? If not, then save up just so that you can reduce your taxes. If you make a contribution to virtually any retirement account (such as an IRA, 401(k), 403(b), or 457), you may be eligible for this credit. If you are self-employed you could consider setting up a self-employed qualified retirement plan (i.e. SEP IRA).
If you wish to start with more than $2,000, you can opt for a Keogh plan, which allows you to put away more into tax-deferred savings for your retirement. Check out line 51 of Form 1040 or line 32 of Form 1040A.
16. Family Business: Get your family into the business. This is a good way to deduct medical expenses for your entire family.
17. Defer Income: Another thing you can legitimately do if you are self-employed, is to defer your income. You can alter your billing slightly to defer income if you see yourself heading into a higher tax bracket. For instance, you can send the last invoices out late in December so that you will more likely receive payment in January.
18. Employer & employee: Being self-employed, you pay both the employer and employee portions of Social Security tax. You can, however, deduct half of these payments on your 1040 form.
19. Raise Expenses: It’s totally legit – you can show increased expenses if you feel you may be headed towards a higher amount as tax. For this, you could make many more year-end business purchases to add some tax deductions before December 31st.
20. Rework Your Portfolio: It’s probably time to review and rework your portfolio. If capital gains are high, consider taking a loss to offset some of the capital gains income.
21. Stock Up: It’s the year-end. How about stocking up? You can buy all of the business equipment and supplies you haven’t yet purchased. Don’t forget to mark and save your receipts.
22. Health Insurance Gains: If you're self-employed and pay qualified health-insurance premiums, then it’s time you check out if you could avail of any deductions. In 2005, tax filers had a good little surprise when they realized that they were eligible to deduct 100% of their qualified health-insurance premiums. Check if the option is still available on Form 1040, line 29. It is important that you review the instructions for this deduction. If you do qualify, you'll save a good amount of money. This means you may not have to take these expenses as a medical deduction on your itemized deduction schedule.
And Some For The Rest Of Us…
23. Got a flexi-spending package? Use it up: A flexi package usually means you have set aside tax-free earnings to cover medical and dental expenses through a plan offered by your employer. It is useless if you don’t use it up. So ensure that you make doctor appointments ASAP and buy all the necessary medical supplies that are covered in the plan.
24. Know the right time to invest in funds: You must be careful about buying an actively managed mutual fund. You could be picking up the capital gains distributions on a mutual fund you hardly own if you purchase it later in the year. What you should do is to check the distribution schedule. If it’s late in the year, wait before you buy the fund.
25. Educator benefits: If you're a teacher or school administrator, you just might qualify for a deduction that will allow you to reduce your taxable income. According to a recent study by the National Education Association, the average K-12 teacher spends approximately $400 annually out of pocket for classroom supplies. You can take up to a $250 deduction on materials purchased. This deduction is also applicable for principals and others who are employed in a school. Check out line 23 on Form 1040 or line 16 of Form 1040A. You don't have to itemize your deductions to claim this deduction, and there are no income limitations.
26. Spend to save: You can pay your state and local taxes in advance. That is if you don't think your personal income tax bracket will be higher next year, and you’re not affected by the alternative minimum tax. Paying your other taxes before the end of the year can help you take a deduction this year.
27. Be Charitable. It saves you money: If you have extra cash, donate money to charity. Save the receipts and use the charitable donations as deductions on your tax return. If you want a big number deduction, keep track of the items you donate and their receipts. The more documentation you have, the higher a deduction you can claim. According to the Internal Revenue Service, a taxpayer can deduct the fair market value of clothing and household goods. All the main rules are laid out in Publication 561, Determining the Value of Donated Property and Publication 526, Charitable Contributions.
There are certain rules to donation though (that is if you want your deductions):
- Firstly check if the IRS recognizes the charity. For this, you can check IRS Publication 78, Cumulative List of Organizations.
- Next, keep signed and dated receipts from the organization receiving your donations.
- Finally, report your charitable deductions on Schedule A of Form 1040.
- If you donate more than $500 worth of goods to charity, you must include Form 8283, Noncash Charitable Contributions, with your tax return.
28. Review Your Medical Expenses: Don’t wait for the year to end to review your medical expenses. These expenses must total at least 7.5 percent of your adjusted gross income (AGI) in order for you to take the medical expense deduction. This doesn’t include only doctor and dentist visits. You can also deduct medical-related expenses that exceed those covered by your insurance plan or are not accepted by your insurance plan. For instance, purchase of glasses, contact lenses, braces, false teeth, lab fees, emergency room visits, medical supplies and laser surgery are all potential medical deductions.
29. Have Children, Save Money: Having a child can mean a lot in terms of expenses. But you also get deduction on your taxes. As of 2005, the total deduction for each child is $700. If you plan to adopt, remember, you will receive a $10,000 tax deduction per child.
30. Student Loan Gains: Student loan interest deduction is one of the most common ways to reduce your taxes without having to itemize your deductions. There are income limitations though, and if your student loans are large, you may not receive a deduction for all of the interest you paid. Check out line 33 on or line 18 on Form 1040A. If you are taking qualified college courses, you should check line 19 on Form 1040A or line 34 on Form 1040.
31. Dependents’ Education: Your own education expenses aren't the only ways to shave a few dollars off your tax liability. You can also claim education deductions for your spouse or your dependants, after deducting the portion paid by college financial assistance or scholarships.
32. Worthless Shares: Did you buy any shares of stock that crashed miserably? If you’ve buried them away, it’s time to let them see light of day, and for you to earn your tax deduction. How? Most taxpayers aren't aware that they can actually avail of a deduction for those worthless shares. All you need to do is sell them to a non-related friend or family member. You can then avail of the deduction.
33. Credit Cards Anybody? Credit cards are not all that bad – if they can save you a few tax dollars, then why not? Do you plan to buy your business computer near the end of the year and charge it? Or probably, you used your credit card to donate to your favorite charity recently. You don’t have to wait until you pay that credit card bill to take the deduction. The IRS treats a credit card charge like any other loan, so you receive the deduction in the year that the charge was made, not in the year that the credit card bill was paid.
34. Travel & Deduct: Did you know that even travel is a deductible expense? Well, not all kinds of travel. If you use your vehicle for charitable purposes or for medical travel, you can claim a deduction. You are allowed to deduct 14 cents per mile for all qualified charitable travel. (If you worked directly with the Hurricane Katrina relief efforts, you can deduct a higher mileage rate of 29 or 34 cents per mile.) You can also deduct your out-of-pocket expenses when you are serving a qualified organization.
Medical travel -- to and from your doctor and dentist visits, are also deductible. For 2005, the medical travel deduction was 15 cents per mile through Aug. 31, and 22 cents per mile for the rest of the year. If you have to travel long distances for your treatment, you can get deductions on the actual cost of the travel, including airfare and lodging.
35. Look After Your Parents: Are you one of the millions of adult children who are looking after ageing parents? Then you can avail of a few tax breaks. If you and your parent meet IRS requirements, you'll be able to claim an added personal exemption on your income tax return. You may be able to reduce your taxable income by $3,200. To be deemed as a dependent for tax purposes, your parent must get more than half of his or her support from you.
Check IRS Publication 501, Exemptions, Standard Deduction, and Filing Information for details and examples. Parental medical costs are also tax deductible. When adding up those parental medical costs, don't forget premiums for supplementary Medicare coverage or long-term care insurance. Once your parent is your dependent, some of these payments that you make can be counted towards your deductible medical expenses.
36. Superannuation Gains: Even with the superannuation surcharge, superannuation is still a tax effective option for high-income earners. If you are self-employed, you can avail of a tax deduction on the first $3,000 of contributions made and 75 percent deduction for additional contributions made up to the maximum allowable. If are an employee, you could consider making additional contributions out of your gross salary.
37. Ask Around: If you still feel that you could save some more money, go ahead and ask around. Many factors influence the amount you pay as tax. You could look for tax help from someone whose profile is similar to that of your own. This can help you find more ways to reduce your tax burden.
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