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| FREE ~ Lite Version Seminar 11
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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:
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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.
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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.
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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.
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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
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…
Go To SMP Membership Full Text Version -- Index List of All Seminars
Get Your SMP Membership Password Here!
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.
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