To have a proper handle on your finances, you need to understand some basic concepts of our tax law. Doing so will enable you to make the right decisions to minimize your tax burden as well as to discuss it intelligently with your accountant. With that in mind, let’s take a look at ten things that should be part of your common knowledge about taxes (we swear we won’t get technical).
- Uncle Sam is your partner – If you have received money, chances are the IRS will take its share, but there are exceptions – gifts, child support, life insurance, inheritances, loan proceeds (as long as the loan is eventually repaid) to name a few, are not taxable.
- Social Security may be taxable – If it is your only income, then most likely not. But if you are like most taxpayers, social security, when combined with other sources of income, will put you over some rather low taxability thresholds that may subject as much as 85% of your SS benefits to tax
- In most cases, you need to itemize to take advantage of the majority of available personal tax deductions – Some exceptions include student loan interest, up to $250 in educator expenses, alimony paid, and penalties on early withdrawal of savings, moving expenses and contributions to a Health Savings Account. These are claimed above-the-line to arrive at adjusted gross income
- Know how the tax extenders affect you – It seems every year Congress waits until the last possible minute to pass these, obsessing over how they will be paid for. Some have been made a permanent part of the tax law, while others are still temporary. For more information, click here.
- What is ordinary income? – The tax code classifies taxable money you receive as either ordinary income or capital gains. Ordinary income is that which does not qualify as long term capital gain and consists of wages, salaries, tips, commissions, bonuses, and other types of compensation from employment, interest, dividends, or net income from a sole proprietorship, partnership or LLC. Since long-term investment is encouraged, long term capital gains are generally taxed at lower rates than ordinary income.
- What is a cash basis taxpayer? – As a cash basis taxpayer, you generally are taxed on what you receive and deduct what you paid in a given year. Most individual taxpayers are cash basis. If you don’t receive your year-end bonus until January, it isn’t taxed until the following year. By the same token, if you make your January mortgage payment on New Year’s Eve, you can deduct the interest in the current year.
- When are you subject to the alternative minimum tax (AMT)? – The AMT is a tax system parallel to that of the regular tax, expanding the amount of income that is taxed by adding items that are tax-free and disallowing many deductions under the regular tax system. You may be subject to AMT if you have income in excess of certain thresholds as well as sizable itemized deductions such as real estate taxes and state income taxes.
- When can you claim a dependent? – There are two types of dependents – your children and qualifying relatives, both of whom must be U.S. citizens or residents (or of Canada or Mexico). Your children can be claimed by only one taxpayer who provides more than half of their support, be under the age of 19 (or a full-time student under 24) and must live with you more than half of the year. Generally, you can claim a relative if they have less than $4,000 of gross income, live with you for the entire year and you provide more than half of their support.
- Under what circumstance should you pay estimated taxes? – Generally, you should make estimated tax payments if you are self-employed or if you expect to receive significant income from non-wage sources such as retirement accounts, rental income, stock sales, interest, dividends, or alimony. Wage-earning couples, particularly those with substantial incomes, may also need to pay estimated taxes if their withholdings are not sufficient to cover the so-called “marriage penalty.”
- Are you liable for taxes on the gain from the sale of your home? – In general, if you own and use your home as your main home for at least two of the five years prior to the sale, you will not owe taxes on any gain that does not exceed $250,000 if you’re single, or $500,000 for married filers. Losses, however, are not deductible.
If you have questions, please contact Victor C. Belgiorno at 516-861-3704 or VBelgiorno@dsjcpa.com.