5 Simple Rules for Keeping Your Tax Bill in Check
by Dan Caplinger Mar 21st 2013 5:00AM
It's getting a lot harder to stay current with all the tax-law changes and to keep your tax bill under control. It's all about identifying favorable provisions and steering clear of traps for the unwary. Follow these five rules and you can minimize the pain.
Back in 1986, the federal tax system was simplified down to just two brackets. Now, we're back up to seven different brackets, ranging from 10 percent to 39.6 percent.Rule 1: Track Your Bracket.
Knowing your tax bracket is important because it tells you how much in extra tax you'll pay for every additional dollar you earn, or how much tax you'll save by taking an additional dollar of deductions.
One common misconception is that if you jump into a higher bracket, you'll have to pay that higher tax rate on your entire taxable income. Tax brackets only apply to the income within the bracket, and you still get the benefit of lower brackets along the way. So don't panic if you get close to a higher bracket -- but be aware that you'll pay more in tax on the final dollars you earn.
Rule 2: Know Your Thresholds.
As if tax brackets weren't hard enough to figure out, you also have to deal with a huge number of income thresholds that determine whether you're eligible for certain tax benefits. Make too much money, and you'll go over the threshold and find yourself unable to take a valuable deduction or credit.
With dozens of different threshold amounts for various tax provisions, it's impossible to list them all here. But if you're hoping to take advantage of tax-saving opportunities, be sure to look at whether an income threshold applies that could limit your savings.
Rule 3: Remember, It's Not Over 'Til It's Over.
As we all discovered on New Year's Day, tax laws can be changed retroactively. In the case of federal taxes, lawmakers used their ability to turn back the clock in ways that were beneficial to millions of Americans when they restored tax benefits that would otherwise have gone away.
But residents of California have found out the hard way that retroactive tax law changes can go against you as well. Last November, voters put tax provisions into law that imposed higher tax rates for high-income taxpayers on their entire 2012 income, even though more than 10 months of the year had already passed. Some small-business owners are fighting the retroactive tax, arguing that they were told earlier that they wouldn't have to pay one of the retroactively imposed taxes, but they face an uphill battle.
Paying taxes that you don't need to pay is the worst move you can make. Yet millions of taxpayers routinely fail to take advantage of all the provisions that can put more money in their pocket, especially when it comes to the complicated Earned Income Tax Credit.Rule 4: Claim What's Coming To You.
This credit, aimed at low- and middle-income workers, not only lets you cut your tax bill but also entitles you to a refund of any excess credit over your regular tax bill. Yet every year, many taxpayers never file to get their credit back. Because you only have three years to file before those refunds are gone forever, it's important to file returns as soon as possible to get the money you deserve.
It's no longer enough to look at the regular provisions of the income tax. More and more taxes are getting added to the books, including this year's Medicare surcharge of 3.8 percent on high-income earners and the return of full payroll taxes after the 2 percentage point tax holiday on Social Security withholding that was in effect in 2011 and 2012. In addition, certain hidden phase-out provisions, such as those that reduce itemized deductions and personal exemptions, can effectively raise your tax rate without being immediately obvious.Rule 5: Beware of Hidden Taxes.
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