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MONTHLY TAX NEWSLETTERFebruary 2008
Ben Franklin was a man ahead of his time. Even though he died more than 100 years before the current income tax code was put into place, one could argue that he gave some pretty good tax advice when he coined the phrase, "A penny saved is a penny earned."
Any time you take advantage of a tax savings opportunity, less of your hard-earned money goes to taxes and, therefore, more ends up in your pocket. So let's follow another piece of advice from Ben, "An investment in knowledge pays the best interest," and review some of the tax breaks available to you these days.
When is $100 worth $155? If you're in the 28 percent tax bracket, that's the value of paying for personal expenses with pre-tax dollars. Whenever post-tax dollars are involved, you need to earn $155 to have $100 left over after paying your federal income taxes, social security taxes, and Medicare taxes. Here are some pre-tax opportunities that might be available to you:
Tax-free opportunities are a relatively recent phenomenon. Prior to some of the tax law changes during the late 1990's, there were very few tax-free options available to taxpayers. Even though you don't get a current tax deduction in most cases, the potential for decades of compounded growth coupled by tax-free withdrawals down the road makes them worth a close look.
With a tax-deferred savings opportunity, you save taxes today, and then generally owe taxes when you withdraw the money later on. Even so, these opportunities make sense for a variety of reasons. For starters, a dollar today is more valuable than a dollar tomorrow, due to the time value of money. Plus, the government lets you invest the taxes you save and keep the compounded earnings on that money. For both these reasons, tax-deferred savings opportunities make a lot of sense.
Be A "Learned Blockhead"
Ben Franklin put it best when he said, "A learned blockhead is a better blockhead than an ignorant one." And with the complexity of today's tax code, Ben warns us that, "By failing to prepare, you are preparing to fail" and will end up paying higher taxes.
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For the most part, calculating your deductions each year is relatively straightforward. Simply tally up the amount you spent, and that's what you deduct. When making your calculations, don't forget to include checks you wrote, purchases made by credit card, and expenses paid through loan disbursements.
A few deductions require you to make a decision, however. For your automobile expenses, you need to decide between basing your deduction on the standard mileage rate or on actual expenses incurred. And if you went on any business trips last year, you'll choose to base your deduction for meals and entertainment on the per-diem rates or on what you actually spent.
When you use your car for business, driving between job sites is deductible. So is driving between your home and a temporary job site, job interviews, and conferences. Commuting between your home and a regular place of business generally isn't tax deductible.
There are two ways for you to calculate your automobile expenses. You can either claim $.485 per business mile driven in 2007 (increasing by a lousy two cents to $.505 for 2008), or you can base your deduction on the percentage of miles your car was driven for business multiplied by the actual costs incurred during the year. Allowable costs include gas, insurance, repairs, parking at home, and either your lease payments, or if you own your car, a factor for depreciation.
Generally, unless you drive your car relatively few miles each year, with most of those miles being allowable business miles, you're better off basing your deduction on the standard mileage rate.
Let's say you lease a car for $400 a month that you drive only 3,000 total miles during the year. And of those miles, 2,000 qualify as deductible business miles. By calculating your deduction based on the standard mileage rate, you'll end up with a deduction of just $970 (2,000 business miles * $.485 per mile).
What would your deduction be based on the actual expenses incurred, assuming you spend $1,200 on insurance, $.10 per mile driven for gas, and $1,200 on parking at home? Based on $7,500 of total automobile expenses (including the lease payments), multiplied by two-thirds (2,000 business miles divided by 3,000 total miles), your allowable deduction for your automobile expenses jumps to $5,000 - more than five times the $970 allowed using the standard mileage rate.
Now let's see what happens if you drive 20,000 total miles during the year. Assuming your allowable business miles remains at 2,000, you can either claim an automobile deduction of $970 based on the standard mileage rate, or $920 based on one-tenth (2,000 business miles divided by 20,000 total miles) of your actual automobile expenses incurred.
There are a few rules that you should be aware of when deciding which method to use to calculate your automobile deduction. According to the IRS, "A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS), after claiming a Section 179 deduction for that vehicle, for any vehicle used for hire, or for more than four vehicles used simultaneously. Revenue Procedure 2006-49 [available at www.irs.gov] contains additional information on these standard mileage rates."
Meal & Entertainment While Traveling
Whenever you’re on a business trip, 50% of your meals and business related entertainment is deductible. You have two ways you can calculate your deduction.
One option is to keep track of the actual money spent during your trip. The easiest way to do this is by keeping all the receipts together, or by charging everything on one credit card. At the end of the trip, simply tally up what you spent.
The other option is to base your deduction on the per-diem rates. Here, the IRS has actually made your life easier by assigning one of six rates to every metropolitan area in the country. Currently, the rates range from $39 to $64. A complete listing of the per diem rates by city can be found at www.gsa.gov. To calculate your deduction using the per diem rates, simply multiply the number of days you were in a city by that city’s rate. It couldn’t be easier, and it relieves you of the burden on keeping track of your individual meals and entertainment receipts.
Which method should you choose? For each trip, you get to decide whether you’ll base your meals and entertainment deduction on the per diem rates or actual expenses.
Claiming Your Business Deductions
Calculating your deductions is one thing. You still need to figure out how to claim them on your tax return.
If you're compensated as an employee, you'll generally report your deductible business expenses on a Form 2106, and claim this deduction as a miscellaneous itemized deduction on the Schedule A. Keep in mind that miscellaneous itemized deductions are only allowable to the extent they exceed 2% of your income, and are not allowable when calculating the Alternative Minimum Tax (AMT).
If you're compensated as an independent contractor, you'll get a much bigger bang for your buck. That's because you'll generally claim your allowable business expenses directly against your self-employment income on your Schedule C.
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