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Seminar 11

Tax Reduction Strategies

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SEMINAR 11: TAX REDUCTION STRATEGIES


Greetings!

Last session, we looked at some general ways to reduce your taxes from an "after-the-fact" approach, i.e., we looked at "what to do with what you have to work with" at the year's end. But, we did not mention that you yourself can affect, and in a large part even control, what those year end numbers will come to be... So, with this in mind, in this session, we will try to develop a strategy that will enable you to control the numbers...before they come to be! And also, we will try to get a more in-depth understanding of taxes in general, and various tax concepts in particular.

This method of tax planning is often referred to as "legal tax avoidance." To get started, here are some general terms that need to be understood:


Tax

A tax is a mandatory pecuniary contribution levied by government under the authority of tax law. The contributions are used for the operation of government and the maintenance of public services. These contributions may include income taxes, social security taxes, use taxes, property taxes, surtaxes, preference items taxes, sales taxes, real estate taxes, gift taxes, excise taxes, tolls, duties, and customs taxes.


Withholding Tax

Withholding tax is a tax levied by the state or federal government. It is withheld from an employee's wages by his employer. It is levied on all salaries and wages paid regardless of the amount paid, the frequency of payment, or the form in which the payment is received. The tax is deducted by the employer at the time such wages or salaries become due. The federal tax amount paid is determined by completing Form W-4. This form takes into consideration the employee's marital status, exemptions, tax credits, and other estimated deductions.


Federal Insurance Contributions Act (FICA)

The FICA is the federal law that regulates social security tax payment. Under the law, the self-employed, employees, and employers must contribute.

If a person's taxable income from self-employment is above the minimum dollar amount in his tax year, a return must be filed to report such income. This tax is his social security tax and enables social security benefits (along with any employee social security taxes paid) upon retirement. The tax is figured on Schedule SE Form 1040. There is a maximum income amount set that is subject to self-employment tax and income over this maximum is not subject to the tax. This cut off point is often changed (usually increased) as is the percentage rate of payment. Current rates and detailed information are found in IRS tax publications #533, #557, and #503 which may be obtained from any IRS office or download them from the WWW.

The tax is also levied on employee's wages and employers who have employees who pay the tax. The employer must match the tax paid by his employee. The payment rates are defined by tax law. For more detailed and current information an employer may procure IRS tax publication #539 from any IRS office or download it from the WWW.

These tax contributions fund both the social security and Medicare programs. All tax contributions are pooled in special trust funds and act as a social insurance policy. The fund insures against loss of earnings due to retirement, death, and disablement. Benefits are paid monthly to the person, or in the case of death, to the family. The amount of benefits paid out are defined by law. For additional information and eligibility requirements contact the nearest Social Security Office and/or obtain tax publications #915 and #525 from any IRS office or download them from the WWW.


Social Security Tax

The Social Security Tax is a federal tax levied according to the Federal Insurance Contributions Act (FICA) on employee's wages and employers who have employees who pay the tax. The employer must match the tax paid by his employee. The payment rates are defined by tax law. For more detailed and current information an employer may procure IRS tax publication #539 from any IRS office or download it from the WWW.

This tax contribution helps fund both the social security and Medicare programs. All tax contributions are pooled in special trust funds and act as a social insurance policy. The fund insures against loss of earnings due to retirement, death, and disablement. Benefits are paid monthly to the person, or in the case of death, to the family. The amount of benefits paid out are defined by law. For additional information and eligibility requirements contact the nearest Social Security Office.


Taxable Income

Taxable income is the Income upon which taxes are levied. Taxable income is calculated by first totaling gross income, i.e., the summation of all income receipts minus the legal income exclusions. From this, allowable adjustments are subtracted to arrive at adjusted gross income. Then the itemized deductions total, or the standard deduction, whichever is greater, is deleted. Next, the appropriate allowance for exemptions (personal, spouse, dependents, etc.) is subtracted out. This leaves the "taxable income" figure. The determination of the amount of tax levied is defined by tax law.


Income Tax

Income tax is a tax, either federal, state, or local that is levied upon an income, e.g., corporate, business, trade, property, investment, royalty, rent, or personal income. The tax is usually levied on yearly profits. Generally, income from all sources both inside and outside the United States is used to figure the tax. However, nonresident aliens are generally taxed only on income from sources in the United States. An income tax treaty may reduce the standard tax rate on nonresident alien's investment income. Income tax liability amounts are defined by tax law. For more detailed information obtain tax publications #1, #525 and #17 from any IRS office or download them from the WWW.


Estimated Tax

An estimated tax is a federal income tax levied on sources of income not subject to withholding tax to include: self-employment income, alimony, rent, dividends, interest, capital gains, prizes, estate, and trust incomes.

The tax is paid in quarterly installments. Generally, each installment is 25% of the full year's tax liability. The sum total required payment in the 4 installments is generally 90% of the total year's liability, or, 100% of the total estimated tax paid the previous year (if the previous year's return covered all 12 months of the year), whichever is less. If the 90% rule is used to pay the tax, the remaining 10% is paid by the filing deadline for that year. Stiff penalties are assessed for failure to meet the 90% payment minimum.

The estimated tax payment covers income taxes, self-employment taxes (also called "social security self-employment taxes") and other taxes due that are reported on Form 1040. For detailed information on how to figure exact amounts due, a taxpayer may obtain a copy of IRS tax publications #505, #542, #519, and #554 from any IRS office or download it from the WWW.


Self-Employment Tax

The Self-Employment Tax (also called "social security self-employment tax") is a tax levied according to the Federal Insurance Contributions Act (FICA) on certain self-employed person's net income. This tax is his social security tax and enables social security benefits (along with any employee social security taxes paid) upon retirement. The tax is figured on Schedule SE Form 1040. Current rates and detailed information are found in IRS tax publication #533 which may be obtained from any IRS office or download it from the WWW.

This tax contribution helps fund both the social security and Medicare programs. All tax contributions are pooled in special trust funds and act as a social insurance policy. The fund insures against loss of earnings due to retirement, death, and disablement. Benefits are paid monthly to the person, or in the case of death, to the family. The amount of benefits paid out are defined by law. For additional information and eligibility requirements contact the nearest Social Security Office.


Federal Unemployment Tax (FUTA)

The Federal Unemployment Tax is a tax imposed on the employer (which is not deducted from employee's wages). Proceeds collected are used in conjunction with state funds to provide unemployment compensation payments to workers who have lost their jobs. Most employers pay both state and federal unemployment taxes. The rates paid depend on the amount of wages paid out per quarter and the type of employee paid. For example, there are some special rules concerning household and farm worker employees. Employers who pay into state programs may receive credits against the amounts otherwise paid into the federal fund. For detailed information defining exactly who must submit FUTA payments, how much the payments are, and when the payments are due, the taxpayer may obtain IRS tax publication #539 available from any IRS office or download it from the WWW.


Use Tax

A use tax is a tax levied on the use of some specified property which is not subject to sales tax, e.g., a tax on free records used in record promotion. For more detailed information obtain tax publication #349 from any IRS office or download it from the WWW.


Business Expense

A business expense is a deductible expense, defined by tax law to be: any ordinary and necessary expenditure incurred by an enterprise seeking to make a profit, e.g., manufacturing and production costs, promotion and advertising costs, bookkeeping costs, audit fees, professional service fees, business travel and entertainment costs (some legally defined limits exist), supplies, utilities, transportation, rent, depreciations, maintenance costs, real property taxes, payroll taxes, unemployment taxes, state taxes, salaries, wages, insurance, commissions paid, amortizations, pension contributions, bad debts, depletions, etc..


Business Use of Home Expenses

Business use of home expenses are expenses that are related to using a part of a home regularly and exclusively as either a principal place of a business or as a place to meet, clients, or customers. The deduction has certain limitations, and in any event, will not create a business loss or increase a net loss for the business.

Deductions in excess of the limit may be carried forward to later years. But the carry forward is subject to the income limits in those years. For more detailed information obtain tax publications #587 and #529 from any IRS office or download them from the WWW.


Bad Debts

Bad debts are accounts and notes receivable that are never to be fully recovered because of a default. Bad debts can be either totally or partially worthless bad debts.

If it will be possible to collect only part of the debt in the future, it is a partially worthless bad debt. If it will be impossible to collect any of the debt in the future (even though part of the debt was received in the past), it is a totally worthless bad debt. There are two deduction classifications for bad debts--business and nonbusiness.

To qualify as a business bad debt, the debt must be closely related to business activity, i.e., the dominant reason for the debt must involve business activity. If this qualification is not met, the debt is considered to be a nonbusiness bad debt.

In the case of corporation bad debts, all bad debts incurred are considered to be business bad debts.


Business bad debts are deductible from gross income. They are deductible using one of two methods:

1) The specific chargeoff method, which allows the deduction of specific business bad debts (these debts need not be charged off on their books as wholly worthless in order to deduct them), and

2) The reserve method (for financial institutions only) which permits the deduction of a reasonable addition to the businesses' reserve for bad debts.


Business bad debts may only be deducted if amounts or notes receivable have already been reported as income in the current or prior year. They are reported on Form 1065 (for partnerships) or Form 1120 (for corporations).

Bad debts that did not result from the activity of a business, i.e., nonbusiness bad debts, must be totally worthless to be deductible.

Nonbusiness bad debts are deducted as short term capital losses. The maximum amount deductible is limited, and is defined by tax law. They are reported on Schedule C Form 1040. For more detailed information obtain tax publications #548 and #908 from any IRS office or download them from the WWW.


Tax Planning, Tax Avoidance and Tax Shelters

Tax Planning is any procedure of forethought by a taxpayer to facilitate the use of tax avoidance methods applicable to his tax situation. Tax avoidance is action taken by a taxpayer to legally minimize the amount of tax he pays, i.e., to legally avoid situations where taxes can be levied. For example, by using alternative tax rates, methods of computation, methods of reporting, or by refraining from, engaging in, or timing certain activities to avoid increased taxation. A tax shelter is any investment, deduction, or device used to facilitate tax avoidance, e.g., monetary investment in a tax exempt pension plan, energy tax credits, tax free municipal bonds, home mortgage interest deductions, etc..


Tax Evasion and Tax Fraud

Tax evasion is the act of illegally avoiding to pay taxes due. All tax evasion is tax fraud. For more detailed information obtain tax publications #556, #586A, and #594 from any IRS office or download them from the WWW.

Tax fraud is an illegal activity that is an intentional perversion of the facts to evade the payment of taxes. If the taxpayer is alleged to have committed tax fraud, the taxpayer has the burden of proving the underpayment is not a result of fraud. Further, the IRS may prosecute the taxpayer in criminal court. There is no statute of limitations for tax fraud. They may prosecute forever, i.e., at any time after the crime is committed. Tax fraud is a felony. The law has penalties for people convicted of felony charges. They may include a fine, imprisonment, or both.

Also, the IRS may assess a severe monetary penalty on the underpayment they determine to be attributed to fraud (even without court action). This penalty equals 75% of the underpayment due to fraud (or to the entire underpayment if fraud cannot be disproved by the taxpayer) plus 50% of the interest due on the underpayment. Interest is charged from the date the tax became due to the date it is paid or to the date it is assessed whichever is earliest. Of course, the taxpayer may challenge the IRS's assertion of fraud via IRS channels or by litigation. For more detailed information obtain tax publications #556, #586A, and #594 from any IRS office or download them from the WWW.


Tax Mistake

A tax mistake is an unintentional perversion of the facts, i.e., an omission of information or inclusion of incorrect information. Tax mistakes are usually either an unintentional overstatement of a deduction, e.g., a business expense deduction, an itemized deduction, etc., or the unintentional understatement of income, i.e., tax negligence.

The word "unintentional" is very important. Unintentional perversion is perversion that is unknowingly or unwillfully committed. Penalties assessed for unintentional perversion are less than penalties for intentional perversion (fraud).

If the IRS thinks a mistake is intentional, they may assume it is fraud (even though it many not be fraud) and assess the stiff penalties for fraud. They may also prosecute in criminal court. If a tax mistake is proven to be intentional via the judicial system, it is no longer a mistake, but fraud.

The taxpayer would try to minimize mistakes since there is always the possibility that the IRS may think an unintentional mistake was done with willful knowledge. Although it is improbable, it is possible that even an objective disinterested court of law could decide that an unintentional mistake was to the contrary--the consequences could be alarming!

If a taxpayer has intentionally changed or distorted facts, or if there is the possibility that a mistake could be determined to be intentional on a return or returns already submitted, voluntarily reporting this to the IRS does not alter the fact that fraud has been committed. The IRS can still prosecute. In cases of fraud they can prosecute anytime after the fact, i.e., there is no statute of limitations.

The unintentional overstatement of a deduction i.e., a tax mistake, will be disallowed by the IRS. They will assess the resulting taxes plus interest (interest is charged from the original date that the tax should have been paid). The interest charged on the assessment due is usually less than the rate at which money is ordinarily borrowed. Also, if the IRS fails to locate and assess an unintentional overstatement of a deduction within the statute of limitations period, the assessment is not allowed. For more detailed information obtain tax publications #556, #586A, and #594 from any IRS office or download them from the WWW.


Tax Negligence

Tax negligence results from the unintentional understatement of income. If the IRS finds that a taxpayer has been negligent, they may make him pay a penalty fee in addition to the assessment plus interest. The penalty is applied to the entire tax underpayment (which is other than fraud--fraud is always penalized as fraud) and not just to the portion attributed to negligence. The amount of the penalty is defined by current tax law. Interest is charged from the date the tax became due to the date it is paid or to the date it is assessed whichever is earliest. Of course, the taxpayer may challenge the IRS's assertion of negligence via IRS channels or by litigation.

If the taxpayer understates his taxes due amount by more than the current tax law allows, he can be assessed a stiff penalty plus interest. For exact current penalties and more detailed information obtain tax publications #556, #586A, and #594 from any IRS office or download them from the WWW.


Tax Assessment

A tax assessment is the tax amount due and collectible under tax law resulting from the valuation of property and/or the valuation of benefit received from property. For more detailed information obtain tax publication #535 from any IRS office or download it from the WWW.


Tax Penalty

A tax penalty is a monetary payment assessed to delinquent taxpayers. This assessment may result where the taxpayer has failed to file a return, has filed a frivolous return, has failed to supply a social security number, where a tax mistake, tax negligence, or fraud exists, or for other reasons defined by tax law. For more detailed information obtain tax publications #556, #586A, and #594 from any IRS office or download them from the WWW.


Tax Audit

A tax audit is an official examination by the IRS to verify the validity of a taxpayer's accounting records such as those which record income, exemptions, and deductions. In the meeting, the taxpayer attempts to prove his return is correct and legal. If his attempt fails and the IRS still says he owes them money, the IRS may sue the taxpayer in court. This can be expensive for the taxpayer. Therefore, a small assessment may sometimes be paid simply to avoid a costly trial. For more detailed information obtain tax publications #1, #334, #556, #586A, and #594 from any IRS office or download them from the WWW.


Tax Court

Short for United States Tax Court. It is an independent agency and part of the executive branch of government. The court tries cases and renders decisions with respect to federal tax overpayment or underpayment. The taxpayer must file a petition for hearing within a definite time period after receiving notice from the IRS of a deficiency in payment. The advantage of litigating in tax court is that IRS assessments, if found to be legitimate, are not paid until after litigation (although interest does accumulate). In Circuit Courts and the Court of Claims the assessment is paid before litigation.



TAX AVOIDANCE--A CLOSER LOOK

Taxes -- SMP Hot Link


If one illegally avoids to pay taxes due he is guilty of a federal criminal offense punishable by fines and imprisonment.

So, when tax avoidance methods are implemented by the taxpayer, it is imperative that he understands what is legal and illegal.

You guessed it…here is where you will need the SMP Membership Full Text Version of Seminar #11, along with the access it gives to the SMP Hot Links…you will find out how to "Take Care of Business" with detailed answers covering:

1) What is Legal and what is Illegal Regarding Taxes…get it right the first time!
2) Tax Fraud, Tax Mistakes and Tax Penalties…don't Get Burned with a Felony!
3) Tax Avoidance…this is actually legal!
4) The Tax Audit by the IRS…the 15 tips you must read!
5) Tax Disagreements…what can you do?
6) Tax Avoidance Methods…this can save you Extremely Big Money!
7) Business Losses--How the IRS Sees It…save yourself a giant headache.
8) The Documentation Back Up…the 11 most important things you need on paper.
9) Maximizing Business Losses…if you don't know how to do this, it will cost you.
10) Performing Artist…self-employed vs. employee taxes--don't get burned!
Taxes -- SMP Hot Link

You get all this and much more with the SMP Membership Full Text Version…

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CONCLUSION

If the taxpayer knows what he is doing and uses all the tax avoidance methods available to him, he will stay out of trouble and reduce his taxes Big Time!


Next seminar (our last session) we will look at a completed outline overview of our 7 point journey through the music industry.


*R*


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