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Tax Time 2006

It's that time of year again. Whether you are receiving a refund, or you have to pay more, taxes are always a daunting task. If you are focused on your finances, taxes are always on your mind. Outlined here are items for general understanding of taxes, items you can use to retroactively help for 2005, easy deductions, and how to get a good start for 2006.

You may have years of work experience under your belt, but you may not have even a rudementary understanding of taxes. That is not to say you are not intelligent; let's face it, taxes are messy. But, here are some quick items to help you understand taxes.

Get Your Tax Refund Faster -- TaxBrain

So, what bracket are you in for federal income tax? Its a simple question, but it is not cleary understood by most taxpayers. The IRS has a nice page they have set up to help you determine your tax bracket given your filing status and income. These brackets indicate your marginal tax rate.

For instance, let's assume that you are married, filing jointly, and your income is the nation average of $60,000 per year. This means that your marginal tax rate is 25%, or that you are in the 25% tax bracket. This does not mean that you are liable for 25% of your income, however. In the table provided on the IRS website, it indicates that you are liable for 25% for any income over $59,400, plus $8,180. This equates to $8,330.

Essentially, you pay taxes at a rate of 10% for income up to $14,600 (married filing jointly), 15% on income exceeding $14,600, but up to $59,400, and 25% on amounts exceeding $59,400. So, if you earn $60,000 you are actually liable for 13.88%, or $8,330 divided by $60,000. As you can see, this is not all that difficult. Now, comes more complex items that allow you to reduce your liability.

The first step to effecting both your liability and your tax bracket is calculating your adjusted gross income, or AGI. AGI is all income minus pre-tax deductions. What are pre-tax deductions? They are deductions that have been deemed by the IRS as an expense for which you should not pay taxes. These include insurance premiums, 401(k) or 403(b) contributions, flexible spending account deductions, and the like. This is the easiest way for you to get into a lower tax bracket, which can dramatically reduce your tax liability. For instance, let's assume that you deduct $150 for insurance premiums, $200 to a 401(k) account, and $50 to a flexible spending account per month. That addes up to $400 per month, or $4,800 per year in pre-tax spending. You then subtract $4,800 for $60,000 and you adjusted gross income is $55,200. This means you are now in the 15% tax bracket, and you tax liability has been reduced from $8,330 to $7,550 ((($60,000 - $4,800) - $14,600) x .15 + $1,460).

Kids are great, aren't they? And, they can bring you an added bit of joy during tax time! You are able to deduct $3,200 for yourself, your spouse, and each child from your adjusted gross income. So, for your family of three you can deduct $9,600 ($3,200 x 3) from your adjusted gross income. Your AGI is now $45,600 and your tax liability is now $6,110. Since you have this child, let's assume that you purchased a new home to accomodate this new child!

Now, you have your base liability out of the way, and you can begin deducting items allowed by the IRS. One of the best deductions around is for mortgage interest on your first and/or second home. Your mortgage company should supply to you a 1098 form that has the facts about your mortgage that are important for tax purposes. Let's assume that everything is simple, and you purchased an average home for about $100,000, and you paid $5,000 in interest for 2005. There are some crazy calculations for determining your deductible interest if you have second mortgages, HELOCs, second homes, etc., but we are going the simple route. If this is you, you can most likely deduct all of your interest and it will go on schedule A. Now, you subtract $5,000 from $6,110 and you are left with $1,110. You have now reduced your liability by ~86% from before adjusted gross income.

Now that you only have $1,100 left to reduce, it get's to the nitty gritty. Here are some things to look for:

  • Charitable Donations

  • Work-related Relocation Expenses

  • Education Expenses (including interest to student loans)

  • The Cost of Tax Preparation

Using tax preparation software, like Turbo Tax, can also help you to find hidden deductions.

So, now that you have a better understanding of some very simple tax deductions, and how taxes work, you can begin to plan for 2006 by utilizing items that you previously left untouched. As stated earlier, pre-tax deductions are quick and easy, and can also help save you money on medical expenses, as well as, help you save for your retirement. You could also get married or have a child... but don't do it for taxes. Beyond that, buy a home. If you do not already have a home, you need to begin to consider what steps you need to take in order to make that happen. Check your FICO score, save for a down payment, reduce your outstanding debt, and search for a mortgage. Buy something that meets your needs, is affordable, and something that can sell quickly if you are ever in that situation.


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