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Did You Pay Too Much in Taxes?

This time of year, taxes are on everyone's mind. As part of preparing your income tax returns, you probably noticed 1) how much income you earned during the year and 2) how much taxes you paid on that income.

If you feel that you paid too much in taxes, take the time necessary to learn about the variety of opportunities available to help you minimize your tax burden and maximize the amount of after-tax dollars that you keep for yourself.

Below is a list of the most common pre-tax, tax-free, and tax-deferred opportunities available to most young professionals:

401(k) & 403(b) plans: (Pre-tax & tax deferred)

These retirement savings plans are only available through your employer's benefit package. Amounts contributed during the year reduce your taxable earnings and grow tax-deferred. Currently, the maximum 401(k) contribution is the lesser of 15% of your compensation, or $10,500 and the maximum 403(b) contribution is the lesser of 20% of your compensation, or $10,500.

Business expenses paid through employer's "slush fund": (Pre-tax)

If you have the option of having your employer pay for some of your out-of-pocket expenses in exchange for a reduced bonus or salary, those expenses will be paid with pre-tax dollars. Assuming you're in the 28% tax bracket, $100 of pre-tax dollars is equivalent to $166 in taxable compensation.

Childcare expenses paid through a Flexible Spending Account: (Pre-tax)

Most employers, as part of their benefits package, allow their employees to elect to have certain expenses paid with pre-tax dollars through a "flexible spending account (FSA)". If you're paying child care expenses, and both you and your spouse work, one of you can set aside $5,000 through the FSA to pay for your dependent's care expenses. The catch is that you need to report the name, address, and taxpayer identification number of the care provider on your tax return, or the $5,000 will become taxable to you again. If you only have one child, paying for the child's care through the FSA will save you a lot in taxes.

College savings plans (529 plans): (Tax-deferred and tax-advantaged)

College savings plans allow you to put away a sizeable amount of money for a child's education. The Massachusetts version of the 529 Plan is managed by Fidelity Investments and is called the U.Fund. New York's 529 Plan is managed by TIAA-CREF, and is tax deductible on your New York income tax return. You can put up to $50,000 away at one time, but then you can't add to that account for the next four years. Amounts contributed grow tax deferred, and when the money is withdrawn to pay for college, the earnings will be taxed at the child's rate.

Disability insurance proceeds: (Either tax-free or taxable)

If you ever receive disability benefits, the portion of the benefit received in connection with premiums paid by your employer are generally taxable. Benefits received in connection with premiums paid personally are tax-free.

Education IRAs: (Tax-free)

Each year, you can contribute up to $500 to an education IRA on behalf of each of your children. Amounts contributed grow tax-free, as long as the money in the IRA is used for the child's college tuition. High income taxpayers (single individuals whose income exceeds $110,000 and married couple's whose income exceeds $160,000) aren't eligible to contribute to Education IRAs. However, you can have another person whose income is low enough contribute to Education IRAs on behalf of your children. Finally, money cannot be contributed to a 529 plan and an education IRA on behalf of one child in any tax year.

Gifts received from parents and relatives: (Tax-free)

If you are the recipient of a gift, you as the donee will not be taxed on that gift. The donor might be subject to a "gift tax" if the gift exceeds the annual limit of $10,000 per person.

Life insurance proceeds: (Tax-free)

As the beneficiary of a life insurance policy, you aren't taxed on the proceeds. Depending on who owned the policy, however, the proceeds might be subject to estate (inheritance) taxes.

Medical expenses paid through a Flexible Spending Account: (Pre-tax)

Most employers, as part of their benefits package, allow their employees to set aside as much as $2,000 through a flexible spending account to be used for medical and dental expenses. The catch, use it or lose it. In other words, if you don't spend the money that is set aside, it won't be refunded to you.

Mutual fund distributions re-invested into the same fund: (Taxable)

If you own a mutual fund in a non-retirement account, and the fund pays out a dividend during the year, you will be taxed on that dividend, even if it's re-invested to purchase additional shares of the fund. You need to keep track of these re-invested dividends, as they will decrease your gain when you ultimately sell the mutual fund.

Principal residence: (Tax-free)

When you sell your principal residence, you won't be taxed on the first $500,000 of gain if you are married, or the first $250,000 of gain if you are single, as long as the home was your principal residence for two out of the previous five tax years. If you sell the house in connection with a job related move, and lived in the house for less than two years, you can exclude a prorated amount.

Roth IRAs: (Tax-free)

Each year, you can contribute up to $2,000 to a Roth IRA, as long as you have earned income, and your income is low enough. If you're single and your adjusted gross income exceeds $110,000, or if you're married, and your combined adjusted gross income exceeds $160,000, you're out of luck. Amounts contributed to a Roth grow tax-free as long as you don't withdraw any of the earnings until you turn 59 ½.

SEPs, SIMPLEs, and Keogh Plans: (Pre-tax and tax-deferred)

If you have some self-employment earnings, or own a small business, you're entitled to set up your own retirement plan. With SEPs, you can contribute up to 13% of your net earnings, with SIMPLEs, you can contribute up to $6,000 plus 3% of your net earnings, and with Keoghs, you can contribute up to 20% of your net earnings. Amounts contributed to these plans reduce your taxable income and grow tax-deferred.

Stocks held in non-retirement accounts: (Tax-deferred and tax-advantaged)

Appreciation earned on your stock portfolio is not taxed until such time that one of your stocks is sold. At that time, if you held onto the stock for more than one year, the gain will be taxed at a maximum rate of 20%. Starting this year, if you purchase a stock and hold it for more than 5 years, the gain will only be taxed at 18%. Planning note: If you hold onto an investment until you die, the stock gets restated to fair market value and no capital gains tax needs to be paid.

Traditional IRAs: (Sometimes pre-tax and always tax-deferred)

Amounts contributed to a traditional IRA may or may not be tax deductible, depending on your income and whether you or your spouse is covered under a retirement plan at work, but will always grow tax-deferred. The maximum annual contribution to an IRA is $2,000 per person.

The rules for spousal IRAs changed recently. If one spouse is covered under a retirement plan at work, and the other does not have access to any retirement plans, the spouse who isn't covered can make a deductible contribution to an IRA, as long as their combined adjusted gross income does not exceed $160,000.

UGMA/UTMA accounts set up for a child: (Taxable)

When you invest money in your child's name, you will need to open either a Uniform Gifts to Minor Act account or a Uniform Transfer to Minors Act account. As the custodian, you're obligated to manage that money prudently. When your child reaches the age of majority, the child can do whatever he or she wants with that money.

If the child is under the age of 14, the first $750 of income is not taxed, the next $750 is taxed at 15% (in 2001), and any additional income is taxed at the parent's rate. Once the child reaches the age of 14, the first $700 is not taxed, and the next $25,000 or so is taxed at 15% (capital gains are taxed at only 10% and capital gains on investments held more than 5 years will be taxed at only 8%, subject to certain restrictions). Planning opportunity: Invest in your own name, and when your child reaches the age of 14, transfer appreciated property to the child. Have you child sell the asset, and pay taxes at the lower rates.

Vacation Home: (Taxable)

When you sell a home that isn't your principal residence, the gain will be taxed. The exclusion of gain as discussed above does not apply. The only way to make the sale tax-free is through a Section 1031 Like-Kind exchange.

Variable Annuities: (Tax-deferred)

Amounts contributed to a variable annuity (VA) grow tax deferred. VA's are a great way to supplement your retirement savings and can also provide some protection against your investment decreasing in value, depending on what elections you make when you purchase the VA.



Income Taxes

Saving and Investing




  • Personal income tax returns are due 4/15/01

  • Request for automatic extension, Form 4868, due 4/15/01

  • 1st Quarter estimates due 4/15/01

  • Due date for funding your 1999 Roth or Traditional IRA is 4/15/01

  • Due date for self-employed individuals to fund their retirement plans is 4/15/01

  • Self-employed individuals who need additional time to fund a retirement plan should file a Form 4868 with the IRS

2000 & 2001 TAX FACTS

  • For 2000, the standard deduction for a single individual is $4,400 and for a married couple is $7,350. A person will benefit by itemizing once allowable deductions exceed the applicable standard deduction. Itemized deductions include state and local income taxes, real estate taxes, mortgage interest, charitable contributions, and unreimbursed employee business expenses.

  • For 2000, the personal exemption is $2,800. Individuals will claim a personal deduction for themselves, their spouse, and their dependents.
  • The maximum earnings subject to social security taxes has been increased to $80,400 in 2001 from $76,200 in 2000.
  • The standard mileage rate has been increased back to $.345 per mile as of January 1, 2001 from a rate of $.325 per mile duirng 2000.
  • The maximum annual contribution to a 401(k) plan or a 403(b) plan remains at $10,500 for 2001.

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