Reduce Your Taxes Legitimately and Build Your Wealth, Part 3

This article continues the overview of the IRC, The Tax Code with a summary of Above the Line Deductions. When people want to legitimately reduce their tax liability, they maximize those benefits available to their situation. It is very helpful to think in advance about your tax situation rather than taking the more common, and less successful approach of thinking about your tax situation after the close of the tax year.

As an example, you may contribute to your IRA the first week of January for the coming year. That is the ideal time for two reasons: You have the maximum time for tax free compounding, and you can then adjust your withholding at your place of employment to reflect this contribution, so less is withheld during the year. Some advisors will encourage their client to utilize a credit line to fund their contribution the first of the year if no ready savings is available, and utilize the extra money in their payroll check to pay off the credit line.

Above the Line Deductions

Above the line deductions are the first adjustments you make after determining your actual income. Generally "above the line" deductions included those incurred through trade or business, paying alimony, reimbursement of employees by employers, qualified plan contributions, and ordinary business adjustments to arrive at your taxable income.

A taxpayer has an opportunity to then adjust your gross income by the standard deduction allowed without any computation appropriate to your situation. An additional above the line deduction occurs for age, blindness, or certain types of disability.

Additionally, you can adjust your gross income by the standard personal exemption.

Below is a partial list of above the line adjustments or deductions:

* Interest for investment purposes.

* Trade or business deductions

* Performing artists, actor expenses

* Employee Business expense under a non-accountable plan

* Alimony

* Interest on certain qualified education loans

* Retirement plan payments into:

* Keogh, IRA, SEP/Sarceps, Simple IRA, Defined Benefit Pension Programs contributions.

* Self employment tax

* Health Insurance Premiums for the self employed

* Moving expenses for moves over fifty miles. (limitations apply)

Above the line deductions have the effect of actually decreasing your taxable income by $1 for every $1 spent, saved or invested. A handy way to look at such a benefit is to imagine you could encourage me to add 40 cents to every dollar you saved. In the first year you would earn or accumulate the earnings on the investment plus my contribution. Therefore an investment that earned 5% in the first year would have the wealth effect of experiencing a 45% return. Why view it this way?

If you don't save the money as agreed, you will have to pay tax on what you do not save. Tax sheltering is like being outside during a rain storm. If you stand out in the rain, you get soaked. If you move under a shelter you remain dry. You do not have to go into the shelter. It just serves your own best interest. You do not have to participate in government sponsored savings program. You just lose the benefit if you do not.

Therefore, the next time you hear someone waxing verbally about how unfair the tax code is, just see the person choosing to stand outside in the rain, while the wise people get under the shelter. Complaining about the rain is a pretty fruitless exercise.

Get into a shelter, or get soaked!

Next Article: Below the Line Deductions
Adapted from the Tax Wise Tutorials.
Donald Clark, Chrysalis Consulting, Inc.

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