Here's How to Beat the IRS. Legally!

TaxTuneup.com is hosted by tax consultant Edward A. Lyon, creator of the TaxCoach Software system for tax and finance professionals. He has appeared on over 200 TV, radio, and internet broadcasts, including CNN's Saturday Morning, CNBC's Power Lunch, MSNBC's Morning Blend and Today in America, Fox News Channel's Fox News Now and Fox on Money, and even Roseanne Barr's short-lived talk show, which dubbed him "the funniest tax guy in America."

Edward A. Lyon, JD
TaxTuneup.com, Inc.
3416 Shaw Ave #5
Cincinnati OH 45208
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elyon@taxtuneup.com

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Paying tax bites. TaxTuneup.com helps you bite back. We give you the tools you need to beat the IRS. Legally!

Our Dictionary of Tax Deductions is all new and updated for 2008. You'll find dozens of new and expanded entries, from arson and kidnapped children to mutual funds and stock options. The Dictionary reveals more than 400 deductions, credits, loopholes, and strategies for investors, entrepreneurs, and families. It remains one of the Internet's most valuable tax-planning resources. 

Good tax planning won't ever be as fun as a hot stock tip. But good tax planning is worth more than any stock tip. And good tax planning can guarantee results. When was the last time you got a guarantee from your stockbroker?

Click on any of our pages to see how we can put cash in your pocket. Let us know what you think of our site. And let us know how we can help you cut your tax.

How to Use The Dictionary

It won't surprise you to see the Dictionary organized alphabetically. I'm not going to throw you any curve balls; you can turn directly to any of the 400+ entries for immediate answers to your tax questions. But here are some ground rules before you dive in:

• Figures for tax brackets, deduction phaseouts, income thresholds, and the like, are current for tax years ending in 2008 unless otherwise indicated.
   

• Hyperlinks are generally cross-references to more Dictionary entries. So, for example, when you read under Business Deductions that " . . . you Depreciate capital assets over their expected life," you'll know to turn to click on Depreciation for more detailed information.
   

• You'll find references to IRS publications for more information. The IRS has recently discovered the English language, and you might be surprised at how helpful their publications can be. You can find tax publications online at http://www.irs.gov; you can also order them at 800/TAX-FORM. These links open in new windows, so be sure to set your popup blocker to allow popups from this site.
   

• You'll also find references to Internet resources. Love it or loathe it, the Internet has become a premiere source of free tax-saving ideas. And the IRS site at http://www.irs.gov is one of the best sites of any government agencies.

How the Tax System Works

"The hardest thing in the world to understand is the income tax."
Albert Einstein

Should our tax system really be so hard that Albert Einstein can't understand it? Today's Internal Revenue Code contains over 3 million words. I haven't read them all, and neither has anyone else. (Einstein wouldn't dream of it.) Where does that leave the rest of us?

The good news is you don't have to be an Einstein to cut your taxes. You just have to know how the tax system works for you -- how it treats your income, your investments, your business, and your family. This doesn't mean leafing through dusty law books, or crunching numbers. (I went to law school because there's no math.) The tax system is really more about definitions than numbers.

Here, in a nutshell, is how the tax system works.

First, add up your taxable income from all sources to figure your total income.

Taxable income includes most of what we think of as income: 

• wages, salaries, and tips
   

• commissions
   

• profit from business
   

• interest and dividends
   

• Capital Gains from the sale of property
   

• pension and Annuity proceeds
   

• rents and royalties
   

• Alimony received
   

• gambling winnings, lotteries, and Deal or No Deal
   

• barter
   

• some employee benefits 
   

• Illegal Income

But taxable income doesn't include every last dollar you take in. Make sure you don't enrich the Treasury with taxes on income you don't have to report:

• Gifts and Inheritances
   

• Loan proceeds
   

• most Life Insurance proceeds and dividends
   

• Municipal Bond interest
   

• Individual Retirement Account rollovers
   

• property settlements between divorcing spouses
   

• Child Support payments
   

• Damages from some lawsuits
   

• workers' compensation proceeds
   

• disability insurance proceeds (if you paid the premiums yourself)
   

• federal tax refunds
   

• state tax refunds (if you didn't previously itemize the tax)
   

• most Scholarships and Fellowships

Next, subtract Adjustments to Income to determine adjusted gross income.

Adjustments to Income are a group of specific deductions that cut your tax by cutting your taxable income. Depending on your income and certain other factors, they may include:

• Individual Retirement Account contributions
   

• Moving Expenses
   

• one-half of Self-Employment Tax paid
   

• self-employed Health Insurance
   

• Qualified Plan contributions
   

• Penalty on Early Withdrawal of savings
   

• Alimony you pay
   

• Student Loan Interest

Total income minus adjustments to income equals adjusted gross income. This figure is important for two reasons:

First, your Personal Exemptions and Itemized Deductions phase out as your adjusted gross income reaches certain levels. Personal Exemptions shrink by 2% for each $2,500 or fraction over the threshold. Itemized Deductions (except for medical expenses, investment interest, casualty and theft losses, and gambling losses) shrink by 3% for each dollar over the threshold, up to a maximum of 80% of total itemized deductions.

Second, many Itemized Deductions are allowed only to the extent they exceed certain percentages of adjusted gross income:

• Medical Expenses are deductible only to the extent they top 7.5% of adjusted gross income.
   

• Casualty and theft losses are deductible only to the extent they exceed $100 plus 10% of adjusted gross income.
   

• Miscellaneous Itemized Deductions are allowed only to the extent they exceed 2% of adjusted gross income.

If your adjusted gross income is $50,000, you can deduct medical expenses only over $3,750. If you have just $3,500 of medical expenses, you're out of luck financially as well as medically.

Next, subtract Itemized Deductions and Personal Exemptions to determine taxable income.

Itemized Deductions are the classic writeoffs most of us think of as "tax deductions." These include:

• Medical Expenses
   

• State and Local Income Taxes
   

• Property Taxes
   

• Mortgage Interest and Home Equity Interest
   

• Casualty and theft Losses
   

• Charitable Gifts
   

• Miscellaneous Itemized Deductions

Itemized deductions grow more valuable as your tax increases. If you're in the 15% bracket, every dollar you deduct cuts your tax by 15 cents. If you're in the 35% bracket, that same dollar deduction cuts your tax by 35 cents.

The starting point for every taxpayer is the standard deduction: $5,450 for single filers; $8,000 for heads of households; $10,900 for joint filers; and $5,450 for married couples filing separately (2008). If your actual itemized deductions are higher than the standard deduction, take your itemized total; if actual deductions are lower, take the standard deduction. (Married couples filing separately must both itemize or both take the standard deduction; you can't have it both ways.) Standard deductions are high enough that less than one out of three taxpayers itemize deductions. There's no magic to using them other than knowing what's out there. This book gives you the most complete, user-friendly list of deductions available.

Personal Exemptions are deductions you get for yourself, your spouse, and each dependent. A dependent is someone who gets more than half of their support from you, and meets certain other tests. Each personal exemption cuts your adjusted gross income by $3,500.

Dependents include:

• your child, stepchild, grandchild, parent or stepparent, sibling or stepsibling, in-law, aunt/uncle, niece/nephew, or anyone else not breaking state law by living with you (in some states, same-sex couples can declare each other dependents),
   

• earning less than $3,500 in taxable income (not including Social Security benefits, Municipal Bond interest, etc.), except for children under age 19 or full-time students under age 24,
   

• who gets more than half their support from you,
   

• who is a U.S. citizen, U.S. resident, or resident of Canada or Mexico, and
   

• who doesn't file a joint return with their spouse (except where each spouse's income is below the filing threshold and they file solely to claim a refund).

You'll need to provide a Social Security number for each dependent you claim. A dependent doesn't have to be alive for a full year to qualify for the full personal exemption. Children born during the year and people who die during the year qualify for personal exemptions.

If you care for a foster child and you can show that actual expenses top the allowance you get from the state, claim the excess as an itemized deduction.

Generally, the custodial parent gets to claim the personal exemption for a child following divorce. However, custodial parents can release their exemption by signing Form 8332 and attaching it to their return.

Consult the tax tables or table of tax brackets to figure your tax.

Our progressive tax system is designed to gather the most tax from those of us most able to pay. And that's how it works. The percentage of income you pay increases with your income. Tax brackets govern the amount of tax you pay on each dollar of income. Your "tax bracket" is the percentage you pay on your last dollar of income. Here are the 2008 tax brackets for various filers:

There are several significant exceptions to these tables. Long-term Capital Gains (gains from the sale of property held for more 12 months) and Qualified Corporate Dividends are generally taxed at no more than 15%, even if your regular tax bracket is far higher. Lower long-term capital gain rates offer investors their single best opportunity to cut their tax.

You'll also need to add in any extra taxes, such as Self-Employment Tax, Nanny Tax, or Alternative Minimum Tax.

Finally, subtract any available Tax Credits and send a check to the IRS.

Tax Credits are like turbocharged tax deductions, only better. Tax deductions cut your taxable income. Every dollar of deduction cuts your tax by whatever percentage of that deduction equals your tax bracket. Every dollar of credit cuts your tax by a full dollar.

Tax deductions grow more valuable as your taxable income rises. As we discussed earlier, if you're in the 15% bracket, every dollar you deduct cuts your tax by 15 cents. If you're in the 35% bracket, that same dollar deduction cuts your tax by 35 cents. But tax credits are more valuable for taxpayers in lower brackets. In the 35% bracket, you need $2,857 in deductions to get the same break as a $1,000 credit. In the 15% bracket, you'd need a whopping $6,666.66 in deductions to equal that $1,000 credit.

There's no shortage of tax credits you can use to cut that final bill:

• Adoption Tax Credit

• Child Tax Credit

• Dependent Care Credit

• Earned Income Tax Credit

• Elderly and Disabled Tax Credit

• Foreign Tax Credit

• Hope Scholarship Tax Credit

• Lifetime Learning Tax Credit

• Low-Income Housing Tax Credit

• Rehabilitation Tax Credit

That's really most of what you need to know. The real issue isn't the numbers. It's what you have to include in your income, what you get to deduct from that income, and where you invest to avoid reporting income at all.