If you are fortunate enough to get a big fat tax return every year, what should you do with that money? It is common to feel like you have a lot of money all of a sudden and want to spend it. I highly recommend that you save this money unless you really need to use it for something. Most of the time, you were doing perfectly fine without the extra money from your tax refund. Just use this as an opportunity to save that money. Put it toward a savings goal whether it is some large expense you were saving up for, a retirement savings account, an emergency fund or general savings.

Personally, I put my tax return right into my savings account. It will go into my savings fund for a down-payment on a house. Every year, when I get my tax return direct deposited into my checking account, the first thing I do is transfer it right into my ING savings account. The general rule that I have set for myself has been that once money goes into that account, it cannot come out (unless for an emergency). Doing this will hopefully decrease the urge to spend the money on something you don’t need. Hopefully, you will e able to significantly boost your savings this year as a result of your tax refund!

The previous post talked about some deductions and credits that you should remember. In this post, we will stress the importance of tax planning.

It is important to plan ahead each year with your taxes. Try to estimate what your total income will be and subtract out all expected exemptions, deductions, and tax credits. What tax bracket will you expect to be in?

For 2009, I expect to jump up an income tax bracket. I am hoping to lower my taxable income so that I can remain in the same bracket. How do I plan on doing this? Here is my goal:

1. As I mentioned in a previous post, I am on the market to buy a house. I hope to be able to purchase my first home this year and pick up a mortgage payment. This way, I will get the $8000 tax credit for first time homebuyers and be able to deduct the interest from my mortgage payments by itemizing my deductions. (Mortgage interest payments are usually the highest itemized deduction so it will make itemizing my deductions more beneficial than taking the standard deduction.)

2. In case I do not purchase a home (it is likely I will not find the right place or will not have the funds), I have increased my contributions to my 401k retirement plan. Since this is nontaxable income, it will effectively lower my taxable income. I also have student loan interest deductions that will lower my taxable income.

I also recommend keeping very good records of all of your spending, especially if you itemize your deductions. Keep records of all your expenses such as receipts and etc. The more organized you are, the easier it will be when you do your taxes each year. In the next post, we will discuss what to do with the money if you do get a tax refund.

In the previous posts in this tax series, I discussed some tax basics and also the basic tax formula. Now, I will list some common tax credits and deductions that you don’t want to miss out on.

Tax Deductions whether you take the standard deduction or you itemize:

1. Business expense deductions – Do you run your own business? Are you an independent contractor? Do you have a home office? If so, you should be making deductions for your business expenses, which are considered above the line deductions.
2. Retirement contributions – Traditional IRA, 401k, etc
3. Student loan interest – up to $2,500/year on qualified student loans
4. Capital losses – losses on investments can offset any capital gains that you had or up to $3,000 in income

Tax Credits:

1. Education Tax Credits – There are two tax credits for education. The Hope Credit is only for those who are in their first two years of post-secondary education. The Lifetime Learning Credit is for anyone who is in school full-time. Details
2. Retirement Savings Contribution Credit – If you make eligible contributions to a qualified retirement plan (401k, IRA) you could qualify for up to a $1000 ($2000 for married filing jointly) tax credit if you fall into a certain income threshold. Details
3. Child Tax Credit – Depending on your AGI and if you take care of a child under the age of 13, you could take a tax deduction for a percentage of your work-related expenses. Details
4. First Time Homebuyer Credit – In the past, this was a tax credit that you would have to pay back eventually. In essence, it was a tax free loan. However, through November of 2009, if you purchase a home for the first time, you can get $8000 in a tax credit and would not have to pay it back.

These are just a few of the deductions and tax credits I could think of off the top of my head. There are plenty more that are available to you. If you would like me to post about those, please comment and let me know that you want me to write about those. Stay tuned for the next post in this series.

In a previous post I began to go through different parts of the tax return. Here is a continuation of that with the basic tax formula so you can see how each part affects your taxes payable or your refund.

What is a personal tax exemption?
A personal tax exemption reduces your taxable income on your tax return. Each personal tax exemption in 2008 is equal to $3,500. You can claim a tax exemption for yourself, your spouse, and each of your dependants.

What are withholdings?
Withholding is the money that is withheld from your paycheck for taxes. Basically, this is the amount of taxes that you have already paid.

Tax Credits vs. Tax Deductions
Tax credits are better than tax deductions. Tax credits are a direct reduction in the amount of taxes you owe. For example, if I owe $4,000 in taxes and I get a tax credit of $2,000, I only owe $2,000 in taxes after the tax credit. A deduction, on the other hand, only lowers your taxable income.
Simple Tax Formula
Here is an example of a very simple tax formula to give you a better picture of what is happening:

Total income
-Nontaxable Income
-Above the line deductions
Adjusted Gross Income (AGI)
-Personal Exemptions
-Itemized or Standard Deductions
Taxable Income
x Applicable tax rate according to your tax bracket
Income Tax Liability (aka income taxes owed)
-Tax Credits
-Tax Withholdings
Taxes Due or Tax Refund (if this is a negative number, it indicates that you have a tax refund)

In the next post of this series I will mention some major/common tax credits and deductions that you should definitely be aware of.

Taxes – Part 1: Tax Basics

In honor of tax season and the rush that is ensuing to get your taxes filed by April 15th, I thought I would write a series about federal income taxes. I highly suggest using a tax reporting software/program to file your taxes this year since it makes filing a lot easier. I use Turbo Tax, but there are a number of other programs out there. Although such tax software simplifies the return, it is still important to understand how your taxes are calculated and how to maximize your tax return. In this part, I will start with the basics of federal taxes.

How are my taxes calculated?
The Internal Revenue Service (IRS) uses income “brackets” to tax you. Basically the higher your income, the more you will be taxed. Of course, there are ways to lower your “taxable income” (your income that is subject to taxes) and we will get into that later. You are taxed differently depending on your filing status (single, head of household, married filing separately, or married filing jointly). The IRS has a formula that calculates how much you are taxed based on your filing status, your income bracket, and your Adjusted Gross Income (AGI). You can check up the formulas for each bracket on the IRS website or basically just search for it online as they are widely published.

What is a dependent?
There are a bunch of rules to determine if someone is your dependent, but simply put, a dependent is someone who you provide more than 50% support for and lives with you. In most cases a dependent is your child. Here is a link to the IRS with specific details: http://www.irs.gov/newsroom/article/0,,id=133298,00.html.
What are the differences between each filing status and which is the best filing status for me?
Obviously, filing as a single individual means that your marital status is single and you do not have any dependents. However, if you do have dependents and you are single, it is more beneficial for you to file as head of household. If you are married, filing jointly usually provides you with the more beneficial tax brackets.

How is AGI calculated?
AGI is your Adjusted Gross Income and it is used as a basis to figure out the taxes you owe. AGI is calculated by taking your income (wages, interest, dividends, capital gains, etc) and subtracting certain deductions that are called “above the line” deductions. Above the line deductions reduce your taxable income and are taken before AGI is calculated. Since the AGI is the number that determines your eligibility for many tax breaks, any deductions above the line are better than below the line. There are a number of above the line deductions, but here are a few common ones that you might want to know about:
· Reimbursed employee expenses
· Moving expenses
· Certain expenses for books and supplies if you are a teacher
· Alimony payments
· Interest on student loans
· Higher education expenses
· Health savings accounts
· Tuition and fees
· Self Employment Health Insurance
· Self Employment Tax (half of it)

What is a standard vs. itemized deduction?
When you file, you can choose to itemize your deductions or to take the standard deduction. A standard deduction is a standard amount that lowers your taxable income from AGI. When you itemize, there is a whole list of deductions that you can take including interest on mortgage payments, charitable contributions, state and local taxes paid, excessive medical expenses, gambling losses, and etc. Unless you have itemized expenses that add up to more than the standard deduction (In 2008 – $5450 for single, $10900 for married filing jointly, $8000 for head of household) it is more beneficial for you to take the standard deduction.

The next post in this tax series will include some more tax basics.