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Babysitter
(See Dependent Care Credit)
Back Supports
Deductible
Medical Expense subject to the 7.5% floor.
Bad Debts
Bad debts are deductible from
gross income in the year the debt becomes worthless"
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Business debts are a deductible
Business Expense on
Schedule C,
Form 1065, or
your corporate return. Bad debts include billings you report under the
accrual method but never collect. But they don't include invoices you just
don't collect.
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If you guarantee a loan and wind up paying
the bill, there's no immediate deduction. You'll need to try and collect
from the deadbeat you guaranteed; if you can't collect from them, then
deduct the loss.
This appears to be an IRS audit "hot button,"
so be sure to document the debt and the loss. To prove a bad debt, you'll
have to show that it was a valid debt arising out of a debtor-creditor
relationship. The funds you use to make the loan had to come from your
income or capital. Finally, you'll have to point to some identifiable event
that convinces you the debt is worthless.
Bad debts from family members are hard to
prove; the IRS presumes they're actually gifts. You don't need to wait until
the debt is actually due to claim the deduction--you can do so as soon as
the debt becomes worthless.
If you choose to forgive the debt, the amount
you forgive will become taxable to the borrower in the year you forgive the
debt. This lets you take some revenge on the deadbeat. Simply send him or
her a Form 1099 for the amount you forgive, and forward a copy to the IRS.
This will document your deduction and stick the borrower with a tax bill.
Barter
Barter proceeds you receive from
the trade of good or services without the use of cash is taxable as ordinary
income.
Basis
Basis is a measure
of cost for figuring Capital Gains and losses on the sale of a
capital assets and investments. Your basis in the asset is your cost, plus
any commissions or fees you pay to acquire the property, plus the cost of
any subsequent improvements, minus any depreciation you take while you own
the asset.
If you acquire an asset in a
Tax-Deferred Exchange, your
basis is the same as the asset for which you exchanged. If you received the
asset as a gift, your basis is the same as it was for the giver; if you
inherit it, your basis is its fair market value at the date of the
decedent's death.
For more information, see
IRS Publication 551, "Basis of Assets."
Basket Portfolios
Basket portfolios are a new wrinkle in managed money, and are
entirely a creature of the Internet. These services let you buy a "basket"
of up to 50 shares that you own individually, generally for a set fee per
month. (Smaller investors may wind up with fractional shares that they trade
through the basket sponsor. Internet and computer cost efficiencies make
this sort of trading affordable.) This individual ownership lets you manage
your taxes by offsetting winners and losers and choosing when to take your
gains. Basket sponsors offer asset allocation and portfolio planning tools
in addition to assembling the baskets. Some services let you trade entire
baskets at specific times of day, while others let you buy and sell
throughout the day.
Basket portfolio fees today range from $20 to
$30 per month, depending on the number of baskets you buy. This means that
an investor with $10,000 would pay a management fee of 3.6%; while an
investor with $100,000 would pay 0.36%. Be sure to compare these fees with
managed money alternatives before investing.
"Below the Line" Deductions
(See Itemized Deductions)
Birth Control Pills
(See Medical Expenses)
Blood
Tests/Transfusions
Deductible
Medical Expense subject to the 7.5% floor.
Bond
A bond is a negotiable
promissory notes promising the return of a specified principal, at a
specified time, along with a specified rate of interest. The two primary
considerations in bond buying are credit quality, which measures the risk
that the borrower will default, and maturity, which determines how the
bond's price will fluctuate as interest rates rise and fall. There are
literally thousands of bond issues available to investors. Government issues
range from the U.S. Treasury to local agencies. Corporate bonds range from
blue-chip giants to Internet start-ups. And foreign issues range from
super-safe British gilts to speculative paper issued by former third-world
colonies.
Bonds aren't tax-efficient because most of
their total return comes from current interest, taxed immediately when you
receive it. But current interest isn't the only tax consideration with a
bond. That's because bond prices rise and fall as interest rates rise and
fall. These price swings can generate capital gains when you sell the bond
or it matures. A bond's total return consists of its annual income, plus or
minus capital gain or loss. Since interest income is taxed today at ordinary
rates, the greater the portion of total return that comes from current
income, the less efficient the bond is. Generally, short- and
intermediate-term bonds pay most of their total return in current income;
long-term bonds pay more in capital gain.
Choose bonds because they make sense as part
of your asset allocation -- your mix of equities, debt, and cash that
determines the bulk of your investment return over time. But make sure you
choose the most tax-efficient bonds for your own particular mix of taxable
and tax-deferred assets. Your choices turn largely on whether you're
investing for current income, or to insulate a growth portfolio from stock
market volatility:
If you're spending your interest income as
you earn it:
If you're reinvesting your interest income as
part of a growth portfolio:
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U.S. Savings Bonds let you defer tax
on interest income until the bond matures. Savings bonds also offer
college funding tax breaks.
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Municipal Bonds and bond funds can
compound over time.
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If you're in the 15% tax bracket, hold your
bonds in tax-deferred retirement accounts.
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Variable
Annuity fixed income
subaccounts work like mutual funds with a tax-deferred wrapper.
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Permanent
Life Insurance contracts
offer tax-deferred growth for buyers who need life insurance protection.
You might think that bonds are your first,
best, and last choice for current income. But it's a mistake to invest
solely for income and ignore future growth. Fixed-income investments
generally pay a lower total return in exchange for the safety of the income
stream. So if you invest solely for income, you give up potential growth.
Also, investing for income means earning the bulk of your return in the form
of interest income, taxable today at your highest rate. If you invest for
income and growth, you can draw your income from long-term capital gains,
taxed when you sell at lower rates. This gives you the best of both worlds
-- higher income and lower taxes. The price, of course, is higher volatility
than with fixed-income-only investments.
Investing for income also leaves you
dangerously exposed to inflation. You already know that inflation eats away
at your purchasing power. If you buy a $100,000 Treasury paying 7%, and
inflation runs 3%, at the end 30 years your $7,000 income will be worth just
$4,116 in today's dollars. But inflation makes your tax bite worse by
converting part of your principal into taxable income. At the end of 30
years, your principal will be worth just $58,800 in today's dollars. And
you'll be paying tax on income equal to 11.9% of that principal, rather than
your original 7%. So inflation makes your tax bite even worse by converting
principal into taxable income.
The solution is to invest for high total
return consisting of income and capital growth. The capital growth protects
your principal and your income from inflation. And it lets you take a part
of your income in the form of long-term capital gains, taxed when you sell
at lower rates.
Example: You have $100,000 and you
need to generate $6,000 of income. You could buy a bond fund yielding 6%,
but you'll sacrifice future growth. Or you could invest in a balanced fund
yielding 3% and averaging 10% total return. Each year, you draw the 3% of
income, draw another 3% from principal, and leave the remaining 4% growth
to compound. Yes, your grandmother told you never to touch principal. But
if she's so smart, how come she isn't rich?
For more information, see
IRS Publication 550, "Investment Income and Expenses."
Bond Premium
A bond premium is
any amount above the bond's face value or call value that you pay to acquire
the bond. If you pay $1,005 for a bond with a $1,000 face value, the premium
is $5.
There are two ways to write off a bond
premium on a taxable bond:
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You can deduct the premium as a
Capital
Loss when you sell the bond.
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You can amortize the premium and deduct it
from your interest income over the course of your ownership. If you choose
to amortize the premium, it will lower your Basis for figuring gain or
loss if you sell the bond before maturity.
You can't deduct a premium you pay to acquire
a Municipal Bond. However, you have to amortize the premium over the
remaining term of the bond to determine any gain or loss on any sale before
maturity.
Example: You pay $1,040 for a bond paying
$60 per year and maturing in eight years at $1,000. You can claim the $40
premium as a capital loss when the bond matures. Or you can deduct $5 from
the bond's interest income each year until maturity. If you amortize the
premium, then sell the bond in just two years, your basis will be $1,030.
Books
Books you buy for a deductible
activity are deductible under the same rules as other expenses for that
activity:
Braces
Deductible
Medical Expense subject
to the 7.5% floor.
Most orthodontists let you
finance braces over time. But this is one medical expense that may be enough to
break that 7.5% floor if you pay all at once.
One strategy might be to take
out a home equity loan to pay for the braces up front. You'll get to write
off the braces, plus the interest that you pay to finance them. This will
cut your taxes even if the cost of the braces doesn't exceed the 7.5% floor
by converting nondeductible personal interest (or nondeductible installment
payments that don't top 7.5% of your adjusted gross income) into deductible
Home-Equity Interest.
Braille Books
Deductible
Medical Expense, subject to the 7.5% floor,
to the extent they cost more than the regular print version.
Breast Reconstruction
Deductible
Medical Expense, subject to the 7.5%
floor, for reconstruction following a mastectomy.
Bribes and Kickbacks
Bribes and kickbacks you pay to
bring in business are generally not deductible if illegal under federal or
state law. This is in keeping with the general rule that illegal expenses
are not deductible.
Briefcase
Bunching Deductions
Bunching deductions is an
effective year-end strategy for making the most of
Itemized Deductions.
That's because they don't start cutting your taxes until after they top your standard deduction. (For 2008, this is $5,450 for
singles, $8,000 for heads of households, $10,900 for joint filers, and
$5,450 for married couples filing separately.) Many taxpayers find their
Itemized Deductions just barely reach
or top the standard deduction and don't give
them real value. In fact, just one out of three taxpayers itemize at all.
The solution here is to "bunch" as many deductible expenses
as possible into a single year, taking maximum advantage that year and
settling for the standard deduction the next. It's relatively easy to do
this by prepaying property taxes, medical insurance, charitable gifts, and
the like.
Example: You're a retired couple,
filing jointly, in the 25% tax bracket, and your itemized deductions total
$11,000 per year. Since the standard deduction is $10,900, your itemized
deductions save you just $25 per year (25% of the $100 difference). If you
pay $8,000 of deductible expenses one year and $14,000 the next, you'll
save an extra $560 the first year at no cost the second.
Bunching helps you maximize
Miscellaneous
Itemized Deductions subject to the 2% floor on adjusted gross income and
Medical Expenses subject to the 7.5% floor. If your miscellaneous expenses don't top the 2% floor, prepay your safe-deposit box
fees, your next year's
Subscriptions to investment publications, and similar expenses to get value
for your deductions every other year. Similarly, if you have unusually high
Medical Expenses in a single year, consider prepaying insurance and other
predictable expenses to maximize your deductions that year.
Here are some more common
bunching candidates:
You ordinarily can't deduct expenses until
you actually pay them. But, if you charge deductible expenses to a
third-party credit card, such as Visa, Mastercard, American Express, or
Discover (as opposed to a store card for purchases made at that store), you
can deduct the expense the year you incur the charge. This is because you
actually incur the obligation to pay when you make the charge. This can help
you accelerate deductions to capture tax savings now, particularly if you
charge the expense near the end of one year and pay early in the next during
the card's interest-free grace period for new purchases.
Burglar Alarm
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Burglar alarm
installation costs are a capital cost included in your property's
Basis for
figuring Depreciation and gain or loss on a sale.
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Ongoing monitoring fees for business
property are deductible as a
Business Expense on
Schedule C,
Form 1065, or
your corporate return.
Business Cards
Deductible as an
Advertising Expense on
Schedule C,
Form 1065, or
your corporate return.
Business Expenses
Business expense are generally deductible
from business income according to two sets of rules. You can deduct ordinary
expenses when you pay them (cash businesses) or accrue them (accrual basis
businesses). And you can Depreciate capital expenses over the useful life of
the asset.
The costs of establishing a business --
investigating potential markets, travel and other expenses related to buying
or establishing a business, and professional fees for attorneys and
accountants --- aren't deductible. You can capitalize them and add them to
your Basis in the business, which will cut your tax on
Capital Gain if
you should sell the business. Or you can amortize the costs over 60 months
beginning in the month you begin the business. Use Part VI of
Form 4562 to
make this election with the business's first return.
Ordinary expenses are the day-to-day costs of
running a business. You can deduct any expenses that are ordinary and
necessary for running the business, paid or incurred in the tax year that
you take the deductions. These include:
If you use the cash method of accounting,
where you report income and expenses as you actually receive and pay them,
you can "bunch" expenses and defer income to reduce or accelerate taxes. For
example, you can delay billing clients until after the close of the year, or
prepay expenses before then. Prepaid expenses are deductible in the year you
pay them. Generally, you can't deduct for expenses that deliver value more
than 12 months past the end of the in which you pay. However, you can deduct
prepayments if there's a substantial business reason for the prepayment and
it doesn't cause a "material distortion" in the year you prepay. (If your
business involves the sale of Inventory, you have to use the accrual method
of accounting, which complicates deducting prepaid expenses.)
Capital expenses are assets or improvements
with a useful life of more than one year. Ordinarily you
Depreciate capital
assets over their expected life. However, you can use
First-Year Expensing to write off tangible personal property you
acquire from unrelated individuals.
For more information, see
IRS Publication 334, Tax Guide for Small Business," and
IRS Publication 535, "Business Expenses."
Business Interruption Insurance Proceeds
Business interruption insurance
proceeds are taxed as ordinary income in the year you receive the proceeds.
Ordinarily, insurance proceeds are nontaxable. However, these particular
proceeds are taxable because they are intended to replace taxable income.
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