- Filing status can be single, married filing jointly,
married filing separately, head of household, or surviving spouse with
dependent child.
- Adjusted gross income (AGI) is the sum of a taxpayer’s
income minus specific subtractions called adjustments. Modified AGI is the
regular AGI with certain adjustments and exclusions added back.
- Taxable income is AGI less deductions and exemption.
- Marginal tax rate is the tax percentage at which the
top dollar of your income is taxed. Also referred to as your tax bracket.
- Alternative minimum tax (AMT) is a tax that you pay if it is higher than tax computed the regular way. Certain deductions, credits and tax benefits are not allowed when computing the AMT.
- Credits reduce your tax dollar-for-dollar and some are
refundable.
- Failing to prepay enough tax through withholding or
estimated payments can result in an underpayment of estimated tax penalty.
No
matter what the season or your unique circumstances, when it comes to your
taxes, planning usually pays off in a lower tax bill. It can be difficult to
understand tax strategies if you are not familiar with the terminologies used
in taxation. The following provides you with the basic details associated with
the most frequently encountered tax terms.
- Filing Status—Generally, if you are married at the end
of the tax year, you have three possible filing status options: married
filing jointly, married filing separately, or, if you qualify, head of
household. If you were unmarried at the end of the year, you would file as
single, unless you qualify for the more beneficial head-of-household status.
A special status applies for some widows and widowers.
Head of household is the most complicated filing status to qualify
for and is frequently overlooked as well as incorrectly claimed. Generally, the
taxpayer must be unmarried AND:
- pay more than one
half of the cost of maintaining his or her home, a household that was the
principal place of abode for more than one half of the year of a
qualifying child or an individual for whom the taxpayer may claim a
dependency exemption, or
- pay more than half the cost of maintaining
a separate household that was the main home for a dependent parent for
the entire year.
A married taxpayer may be considered unmarried for the purpose of
qualifying for head-of-household status if the spouses were separated for at
least the last six months of the year, provided the taxpayer maintained a home
for a dependent child for over half the year.
Surviving spouse (also referred to as qualifying widow or widower)
is a rarely used status for a taxpayer whose spouse died in one of the prior
two years and who has a dependent child at home. Joint rates are used, but no
exemption is claimed for the deceased spouse. In the year the spouse passed
away, the surviving spouse may file jointly with the deceased spouse if not
remarried by the end of the year. In rare circumstances, for the year of a
spouse’s death, the executor of the decedent’s estate may determine that it is better
to use the married separate status on the decedent’s final return, which would
then also require the surviving spouse to use the married separate status for
that year.
·
Adjusted
Gross Income (AGI)—AGI is the acronym for adjusted
gross income. AGI is generally the sum of a taxpayer’s income less specific
subtractions called adjustments (but before the standard or itemized deductions
and exemptions). The most common adjustments are job-related moving expenses,
penalties paid for early withdrawal from a savings account, and deductions for
contributing to an IRA or self-employment retirement plan. Many tax benefits
and allowances, such as credits, certain adjustments, and some deductions are
limited by a taxpayer’s AGI.
·
Modified
AGI (MAGI)—Modified AGI is AGI (described
above) adjusted (generally up) by tax-exempt and tax-excludable income. MAGI is
a significant term when income thresholds apply to limit various deductions,
adjustments, and credits. The definition of MAGI will vary depending on the
item that is being limited.
·
Taxable
Income—Taxable income is AGI less deductions (either standard or itemized) and exemptions. Your taxable income is what your regular tax is based upon using the tax rate schedule. The IRS publishes tax tables that are based on the tax rate schedules and that simplify tax calculation, but the tables can only be used to look up the tax on taxable income up to $99,999.
·
Marginal
Tax Rate (Tax Bracket)—Not
all of your income is taxed at the same rate. The amount equal to the sum of your
deductions and exemptions is not taxed at all. The next increment is taxed at
10%, then 15%, etc., until you reach the maximum tax rate. When you hear people
discussing tax brackets, they are referring to the marginal tax rate. Knowing
your marginal rate is important because any increase or decrease in your
taxable income will affect your tax at the marginal rate. For example, suppose
your marginal rate is 25% and you are able to reduce your income $1,000 by
contributing to a deductible retirement plan. You would save $250 in federal tax
($1,000 x 25%). Your marginal tax bracket depends upon your filing status and
taxable income. You can find your marginal tax rate using the table below.
Keep in mind when using this table that the marginal rates are step functions
and that the taxable incomes shown in the filing-status column are the top
value for that marginal rate range.
2013 MARGINAL TAX RATES
|
TAXABLE INCOME BY FILING STATUS
|
Marginal
Tax Rate
|
Single
|
Head of Household
|
Joint*
|
Married Filing Separately
|
10.0%
|
8,925
|
12,750
|
17,850
|
8,925
|
15.0%
|
36,250
|
48,600
|
72,500
|
36,250
|
25.0%
|
87,850
|
125,450
|
146,400
|
73,200
|
28.0%
|
183,250
|
203,150
|
223,050
|
111,525
|
33.0%
|
398,350
|
398,350
|
398,350
|
199,175
|
35.0%
|
400,000
|
425,000
|
450,000
|
225,000
|
39.6%
|
Over 400,000
|
Over 425,000
|
Over 450,000
|
Over
225,000
|
*
Also used by taxpayers filing as surviving spouse
- Taxpayer &
Dependent Exemptions—You are allowed to claim a personal exemption for yourself,
your spouse (if filing jointly), and each individual who qualifies as your
dependent. The amount you are allowed to deduct is adjusted for inflation
annually; the amount for 2013 is $3,900.
- Dependents—To qualify as a dependent, an individual must be the
taxpayer’s qualified child or pass all five dependency qualifications: the
(1) member of the household or relationship test, (2) gross income test,
(3) joint return test, (4) citizenship or residency test, and (5) support
test. The gross income test limits the amount a dependent can make if he
or she is over 18 and does not qualify for an exception for certain
full-time students. The support test generally requires that you pay over
half of the dependent’s support, although there are special rules for
divorced parents and situations where several individuals together provide
over half of the support.
- Qualified Child—A qualified child is one who meets the following
tests:
(1)
has the same principal place of abode as the taxpayer for more than half of the
tax year except for temporary absences
(2)
is the taxpayer’s son, daughter, stepson, stepdaughter, brother, sister,
stepbrother, stepsister, or a descendant of any such individual
(3)
is younger than the taxpayer
(4)
did not provide over half of his or her own support for the tax year
(5)
is under age 19, or under age 24 in the case of a full-time student, or is
permanently and totally disabled (at any age)
(6)
was unmarried (or if married, either did not file a joint return or filed
jointly only as a claim for refund)
- Deductions—Taxpayers can choose to itemize deductions or use the
standard deductions. The standard deductions, which are adjusted for inflation
annually, are illustrated below for 2013.
Filing Status
|
Standard Deduction
|
Single
|
$6,100
|
Head
of Household
|
$8,950
|
Married
Filing Jointly
|
$12,200
|
Married
Filing Separately
|
$6,100
|
The
standard deduction is increased by multiples of $1,500 for unmarried taxpayers
who are over age 64 and/or blind. For married taxpayers, the additional amount
is $1,200. The extra standard deduction amount is not allowed for elderly or
blind dependents. Those with large deductible expenses can itemize their
deductions in lieu of claiming the standard deduction.
Itemized
deductions include:
(1) Medical
expenses, limited to those that exceed 10% of your AGI for the year (Note: The
limitation is 7.5% of AGI for seniors age 65 and older through 2016.)
(2)
Taxes consisting primarily of real property taxes, state income (or sales) tax,
and personal property taxes
(3)
Interest on qualified home debt and investments; the latter is limited to net
investment income (i.e., the deductible interest cannot exceed your investment
income after deducting investment expenses)
(4)
Charitable contributions, generally limited to 50% of your AGI, but in certain
circumstances the limit can be as little as 20% or 30% of AGI
(5)
Miscellaneous employee business expenses and investment expenses, but only to
the extent that they exceed 2% of your AGI
(6) Casualty
losses in excess of 10% of your AGI plus $100 per occurrence
(7)
Gambling losses to the extent of gambling income, and certain other rarely
encountered deductions
·
Alternative
Minimum Tax (AMT)—The Alternative Minimum Tax is
another way of being taxed that taxpayers frequently overlook. An increasing
number of taxpayers are being hit with AMT. The Alternative Minimum Tax (AMT)
is a tax that was originally intended to ensure that wealthier taxpayers with
large write-offs and tax-sheltered investments pay at least a minimum tax.
However, even taxpayers whose only “tax shelter” is having a large number of
dependents or paying high state income or property taxes may be affected by the
AMT. Your tax must be computed by the regular method and also by the
alternative method. The tax that is higher must be paid. The following are some
of the more frequently encountered factors and differences that contribute to
making the AMT greater than the regular tax.
o
Personal and dependent exemptions are not allowed for the AMT. Therefore, separated or
divorced parents should be careful not to claim the exemption if they are
subject to the AMT and instead allow the other parent to claim the exemption.
This strategy can also be applied to taxpayers who are claiming an exemption
under a multiple support agreement.
o
The standard deduction
is not allowed for the AMT, and a person subject to the AMT cannot itemize for
AMT purposes unless he or she also itemizes for regular tax purposes.
Therefore, it is important to make every effort to itemize if subject to the
AMT.
o
Itemized deductions:
§ Medical deductions are
allowed in excess of 10% of AGI from 2013 through 2016. The amount of
deductible medical expenses for regular tax and AMT will be different for
seniors, who are allowed to claim medical deductions in excess of 7.5% of AGI
for regular tax during this period. For other taxpayers, the medical deductions
allowed for regular tax and AMT will be the same.
§ Taxes are not
allowed at all for the AMT.
§ Interest in the form
of home equity debt interest and interest on debt for non-conventional homes
such as motor homes and boats are not allowed as AMT deductions.
§ Miscellaneous deductions
subject to the 2% of AGI reduction are not allowed against the AMT.
o
Nontaxable
interest from private activity bonds
is tax free for regular tax purposes, but some is taxable for the AMT.
o
Statutory
stock
options (incentive stock options)
when exercised produce no income for regular tax purposes. However, the bargain
element (difference between grant price and exercise price) is income for AMT
purposes in the year the option is exercised.
o
Depletion
allowance in excess of a taxpayer’s basis in the property is not
allowed for AMT purposes.
A certain amount of income is exempt from the AMT, but the AMT exemptions are
phased out for higher-income taxpayers. The amounts shown are for 2013.
AMT EXEMPTIONS & PHASE OUT
|
Filing
Status
|
Exemption Amount
|
Income Where Exemption Is
Totally Phased Out
|
Married
Filing Jointly
|
$80,800
|
$477,100
|
Married
Filing Separate
|
$40,400
|
$238,550
|
Unmarried
|
$51,900
|
$323,000
|
AMT TAX RATES—2013
|
AMT Taxable Income
|
Tax Rate
|
0 – $179,500 (1)
|
26%
|
Over $179,500 (1)
|
28%
|
(1) $89,750 for married
taxpayers filing separately
Your tax will be whichever is higher of the tax computed the regular way and the
Alternative Minimum Tax. Anticipating when the AMT will affect you is
difficult, because it is usually the result of a combination of circumstances.
In addition to those items listed above, watch out for transactions involving
limited partnerships, depreciation, and business tax credits only allowed
against the regular tax. All of these can strongly impact your bottom-line tax
and raise a question of possible AMT. Tax Tip: If you were subject to the AMT
in the prior year, itemized your deductions on your federal return for the
prior year, and had a state tax refund for that year, part or all of your state
income tax refund from that year may not be eligible for inclusion in the
regular tax computation. To the extent that you received no tax benefit from
the state tax deduction because of the AMT, that portion of the refund is not eligible
for inclusion in the subsequent year’s income.
·
Tax Credits—Once your tax is computed, tax credits can reduce the tax
further. Credits reduce your tax dollar for dollar and are divided into two
categories: those that are nonrefundable and can only offset the tax, and those
that are refundable. In addition, some credits are not deductible against the
AMT, and some credits, when not fully used in a specific tax year, can carry
over to succeeding years. Although most credits are a result of some action
taken by the taxpayer, there are two commonly encountered credits that are
based simply on the number of your dependents or your income. These and a third
popular credit are outlined below.
o
Child Tax
Credit—The child tax credit is $1,000 per
child. If the credit is not entirely used to offset tax, the excess portion of
the credit, up to the amount that the taxpayer’s earned income exceeds a
threshold ($3,000 for 2011–2017) is refundable. Taxpayers with three or more
qualifying dependent children may use an alternate method for figuring the
refundable portion of their credit. The credit is allowed against both the
regular tax and the AMT for each dependent under age 17. The credit begins to
phase out at incomes (MAGI) of $110,000 for married joint filers, $75,000 for
single taxpayers, and $55,000 for married individuals filing separate returns.
The credit is reduced by $50 for each $1,000 (or fraction of $1,000) of
modified AGI over the threshold.
o
Earned Income
Credit—This is a refundable credit for a
low-income taxpayer with income from working either as an employee or a
self-employed individual. The credit is based on earned income, the taxpayer’s
AGI, and the number of qualifying children. A taxpayer who has investment
income such as interest and dividends in excess of $3,300 (for 2013) is
ineligible for this credit. The credit was established as an incentive for
individuals to obtain employment. It increases with the amount of earned income
until the maximum credit is achieved and then begins to phase out at higher incomes.
The table below illustrates the phase-out ranges for the various combinations
of filing status and earned income and the maximum credit available.
2013 EIC PHASE-OUT RANGE
|
Number of
Children
|
Joint Return
|
Others
|
Maximum
Credit
|
None
|
$13,310 – $19,680
|
$7,970 – $14,340
|
$487
|
1
|
$22,870 – $43,210
|
$17,530 – $37,870
|
$3,250
|
2
3
|
$22,870 – $48,378
$22,870 – $51,567
|
$17,530 – $43,038
$17,530 – $46,227
|
$5,372
$6,044
|
o
Residential Energy-Efficient Property Credit—This credit is generally for energy-producing systems that
harness solar, wind, or geothermal energy, including solar-electric, solar
water-heating, fuel-cell, small wind-energy, and geothermal heat-pump
systems. These items qualify for a 30% credit with no annual credit limit.
Unused residential energy-efficient property credit is generally carried over
through 2016.
·
Withholding
and Estimated Taxes—Our “pay-as-you-go” tax system
requires that you make payments of your tax liability evenly throughout the
year. If you don’t, it’s possible that you could owe an underpayment penalty.
Some taxpayers meet the “pay-as-you-go” requirements by making quarterly
estimated payments. However, when your income is primarily from wages, you
usually meet the requirements through wage withholding and rely on your
employer’s payroll department to take out the right amount of tax, based on the
withholding allowances shown on the Form W-4 that you filed with your employer.
To avoid potential underpayment penalties, you are required to deposit by
payroll withholding or estimated tax payments an amount equal to the lesser of:
1) 90% of the current year’s tax liability; or
2) 100% of the prior year’s tax liability or, if your AGI
exceeds $150,000 ($75,000 for taxpayers filing as married separate), 110% of
the prior year’s tax liability.
If
you had a significant change in income during the year, we can assist you in
projecting your tax liability to maximize the tax benefit and delay paying as
much tax as possible before the filing due date.
Please call our office if we can be of
assistance with your tax planning needs.
(601) 649-5207