By Rita Cheng, CRPC®, CFP®
CEO, Blue Ocean Global Wealth
In the United States, April 15 is Tax Day — the day on which individual income tax returns are due to the Internal Revenue Service (IRS) and the state or local tax-collection agency.
Some folks wait until the 11th hour to file their tax return and satisfy any outstanding tax obligations. Income tax returns may be filed on paper or electronically. Some people find preparing their tax returns overwhelming and complicated. Here are some strategies to make the process less taxing.
Stay on top of the situation by preparing the following items:
Personal information. Name, dates of birth, Social Security Numbers of everyone who is covered in your tax return, and where to deposit your tax refund.
Information about your income. Gather all the information you need to accurately report your income to the IRS, such as:
- W-2 forms,
- 1099 MISC for any consulting income you or you spouse received as an independent contractor,
- 1099-INT, -DIV, -B, or K-1s for investment or interest income,
- 1099-G forms for unemployment income,
- 1099-R for state or local tax refunds,
- Form 8606 for payments/distributions from IRAs or retirement plans,
- SA-1099 for Social Security benefits received, etc. to accurately report your income to the IRS.
Adjustments to your income. These can help reduce the amount of your taxable income, which can increase your tax refund, or reduce the amount your tax bill/liability. Some common adjustments to income include the following:
- Form 1098-E for student loan interest paid
- Form 1098-T for tuition paid
- IRA contributions made during the year
- Contributions to a Medical Savings Account (MSA)
- Health insurance premiums for self-employed individuals
- Moving and relocation expenses
- Alimony paid and contributions to self-employed retirement plans
Deductions and credits. The government offers a number of deductions and credits to help lower the tax burden on individuals and families, which can result in tax savings or a lower tax bill. It is important to understand the distinction between a tax deduction and a tax credit:
- Tax credit refers to the amount of money a taxpayer can subtract from the amount of his or her tax obligation to the government. Tax credits provide instant gratification since it gives instant tax relief. This directly reduces the amount of an income tax obligation by the amount of the credit. (For example, if a taxpayer owed $5,000 in federal income taxes and received a $1,000 tax credit, the taxpayer would only owe $4,000.)
- Tax credits reduce the actual amount of the tax liability, whereas tax deductions and exemptions reduce the amount of taxable income. Receiving a $1,000 tax deduction may only reduce a tax bill by several hundred dollars. In other words, dollar for dollar, tax credits are more valuable than tax deductions.
- Tax deductions do not directly reduce the amount of the tax liability. The purpose of tax deductions is to decrease taxable income, thereby reducing the tax obligation to the federal government. There are many methods to utilize deductions to reduce taxable income, but many people don’t understand them. The earlier in the year individuals and families learn about possible tax deductions, the easier it will be to benefit from them. Many people mistakenly assume that deductions just apply to high-net-worth individuals and families. To determine what tax deductions apply to your situation, it is prudent to consult with a qualified tax professional. They can assess a client’s specific situation and show the client how to take advantage of tax deductions in the most efficient and compliant manner.
Here are some examples of common deductions: Childcare costs, education costs (Form 1098-T), education expenses, adoption costs, home purchase expenses (Forms 1098: Mortgage interest, private mortgage insurance or PMI, and points), investment interest expenses, and charitable donations. Among the many miscellaneous tax deductions are union dues, and unreimbursed employee expenses (uniforms, supplies, seminars, continuing education, publications, travel, etc.).
Here are strategies that you can utilize as you prepare your 2013 tax return.
Don’t despair if as you read this list you realize you might have overlooked certain deductions. If you have already submitted your tax return, you can send IRS Form 1040X to amend your return. As always, be certain to discuss your specific situation with a qualified tax professional.
- Provide dependent SSNs on your return. After you have a baby, apply for your child’s SS card right away. If you do not have the SSN by the tax-filing deadline, the IRS advises that you file an extension rather than submit a return without a SSN.
- File jointly if you’re a same-sex married couple. Married, same-sex couples now have the same federal tax-filing responsibilities as heterosexual couples. Following the Supreme Court invalidation of the Defense of Marriage Act (DOMA), the IRS advises same-sex couples to file jointly or as a married couple filing separately even if the state where they reside does not recognize their marriage. While this can simplify tax filing for same-sex couples on a federal level, they must still file their state tax returns as single taxpayers.
- Claim the Simplified Home Office Deduction. For 2013 returns filed in 2014, the IRS now offers a simplified home office deduction. The new optional deduction is $5 for each square foot of home office space up to a maximum of 300 square feet. This new simplified home office deduction may result in a maximum $1,500 annual home office deduction
- Out-of-pocket charitable contributions. Of course, don’t overlook charitable gifts that you made throughout the year. If you drove your car for charity in 2013, remember to deduct 14 cents per mile, plus parking and tolls. Ingredients for baked goods for community events and meals for the homeless shelter, as well as postage and supplies for fundraising are considered charitable contributions.
- Student loan interest. You can deduct student loan interest only if you are legally required to repay the debt. If parents pay their child’s student loans, the IRS treats the money as if it were given to the child, who then paid the debt. A child who is not claimed as a dependent can qualify to deduct up to $2,500 of student loan interest. The child does not have to itemize to take advantage of the deduction.
- Job-search costs. Transportation expenses of 56.5 cents per mile for driving, parking, and tolls are tax deductible. Employment agency fees, and costs of printing resumes and business cards are tax deductible. Although job-hunting costs are not deductible when looking for your first job, moving expenses are. You do not need to itemize.
- Military Reservists travel expenses. To qualify you must travel more than 100 miles from home and stay overnight. If you qualify, you can deduct the cost of lodging and half the cost of meals, plus 56.5 cents per mile, parking fees and tolls.
- Deduction of Medicare premiums. Clients who continue to run their own businesses after qualifying for Medicare can deduct the premiums they pay for Medicare B, Medicare D, and Medigap coverage. This deduction is available whether or not you itemize. This deduction is not subject to the 7.5 percent of AGI test that applies to medical expenses.
- Refinancing Points. When you purchase a house, you can deduct the points you paid to secure your mortgage. When you refinance, you have to deduct the points on the new loan over the life of the loan. In other words, if you have a 30-year mortgage, you can deduct 1/30th of the points a year. Every little bit helps!
- Reinvestment of dividends. If you have mutual funds, dividends automatically used to purchase additional shares increase your initial investment or “basis” in the fund. Neglecting to include reinvested dividends in your basis can result in the double taxation of dividends: first when the dividends were paid out and reinvested and second when the dividends were included in the proceeds of the sale.
Now that you’ve got that under control, here are several strategies to help you save money on your taxes—today and in the future.
- If you haven’t already funded your retirement account for 2013, do so by April 15, 2014. That’s the deadline for contributions to a traditional IRA, deductible or not, and to a Roth IRA.
- If you are self-employed, consider other options, such as a SEP IRA. You can file an extension to October 15, 2014, to allow yourself extra time to fund your 2013 contributions into those accounts.
- Making a deductible retirement account contribution will help you lower your tax bill this year. Plus, your contributions will compound tax-deferred. If you invest $5,000 a year for 20 years in an investment with an average annual 8 percent return, your $100,000 in contributions will grow to $247,000. The same investment in a taxable account would grow to only about $194,000 (assuming a 25 percent federal tax bracket and perhaps less if you have to account for state taxes).
To qualify for the full, annual IRA deduction for tax year 2013:
- (1) You must not be eligible to participate in a company retirement plan, or (2), if you are eligible, you must have an adjusted gross income of $59,000 or less for singles, or $95,000 or less for married couples filing jointly. If you are not eligible for a company plan but your spouse is, your traditional IRA contribution is fully deductible, provided your combined gross income does not exceed $178,000.
- For 2013, the maximum IRA contribution you can make is $5,500 ($6,500 if you are age 50 or older by the end of the year). For self-employed persons, the maximum annual addition to SEPs and Keoghs for 2013 is $51,000.
- Although choosing to contribute to a Roth IRA instead of a traditional IRA will not cut your 2013 tax bill—Roth contributions are not deductible—it could be the better choice because all withdrawals from a Roth can be tax-free in retirement.
- Diversification with regard to taxation of investments can be just as important as diversification of asset class (stocks and bonds, growth versus value, large cap, mid-cap, small cap, international).
- Withdrawals from a traditional IRA are fully taxable at ordinary rates in retirement. To contribute the full $5,500 ($6,500 if you are age 50 or older by the end of 2013) to a Roth IRA, you must earn $112,000 or less a year if you are single or $178,000 if you’re married and file a joint return.
Marguerita M. Cheng, CFP® is the CEO of Blue Ocean Global Wealth, which provides corporations and institutions with portfolio construction, investment due diligence, and risk-management consulting services. The firm works with families, entrepreneurs, and executives to help them identify and achieve their financial goals. As a CFP Board Ambassador, she helps educate the public, policy makers, and media about the benefits of competent, ethical financial planning.
A Financial Planning Association (FPA) national board member and member of the finance committee, Cheng served eight years on the board of directors of her alma matter, The Robert H. Smith School of Business at University of Maryland, where she collaborated to increase alumni engagement and developed asset management education programs. She is also the president of the Blue Ocean Economic Empowerment Fund.
Cheng says her greatest joy and passion is touching the lives of others so that they may achieve their personal financial success.
For more information, visit www.blueoceanglobalwealth.com.
Securities offered through Private Client Services, LLC. Member FINRA | SIPC. Advisory products and services offered through Blue Ocean Global Wealth, a registered investment advisor. Private Client Services, LLC and Blue Ocean Global Wealth are not affiliated entities.
Blue Ocean Global Wealth intends that this article will be viewed for informational purposes only. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.