Four IRS-Approved Tax Shelters
"Tax shelter" isn't always a bad, bad thing.
You can, in fact, shelter some of your income from taxes without moving a cent to some obscure European tax haven. You don't even have to be rich.
Best of all, you can do it and not worry about raising tax-examiner eyebrows.
All you have to do is let the Internal Revenue Service help.Yes, the U.S. tax code contains several tax shelters. But first, some linguistic clarification. Tax avoidance, or the minimization of your tax liability, is entirely acceptable, as long as you do so legally. It's tax evasion, the failure to pay or report taxes or to report them incorrectly, that will get you into big trouble with the feds. Strictly speaking, a tax shelter is any method of reducing taxable income so that your eventual tax bill is smaller. With that in mind, here are four legal, easy and IRS-approved tax shelters.
Individual retirement accounts, both Roth or traditional, offer tax advantages. Roth contributions are taxable when you make them, but distributions when you retire are tax free. For some, traditional IRAs are appealing because contributions are immediately deductible, but the earnings are taxed when they are eventually withdrawn. Similarly, 401(k) and similar tax-deferred workplace retirement plans allow you to save for your golden years while reducing today's tax bite. Some companies offer Roth 401(k)s that, like their IRA namesake, are taxed upfront but not at distribution.
Yes, even in this real estate market, owning your home is good tax move. Not only are your mortgage interest and property taxes deductible, some taxpayers now also might be able to write off private mortgage insurance premiums. When you sell, your personal real estate could be an even bigger tax shelter. A single homeowner can exclude $250,000 in home-sale profit from taxation; the amount of tax-sheltered profit is double that for married couples.
Long-term investments are a great way to save. Not only have they historically appreciated, when you do sell them, the applicable capital gains tax (5% or 15% depending on your income) is substantially lower than ordinary income tax rates, which go as high as 35%. In 2008, the news gets even better. For some lower-income investors, the capital gains tax rate on long-term investments is zero.
Yes, children do have substantial nontax costs, but when it comes to the Internal Revenue Code, little Jimmy and Janie offer several ways to reduce a tax bill. First, they count as exemptions worth several thousand dollars. For 2007, that gives you $3,400 per exemption to reduce your income. Even better, most parents can claim a $1,000 per child tax credit. This is $1,000 or more that, once you figure how much you owe Uncle Sam, is subtracted directly from your tax bill. The cost of sending the kids to daycare so you can work also could help cut your tax bill thanks to the Child and Dependent Care credit. And once the kids head to college, several educational tax breaks -- tuition and fees deduction and Hope and Lifetime Learning credits -- can help you shave a few more dollars off your annual IRS bill.
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