Tax Savings

Written by Lori Covington
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Wondering about tax savings? There are two ways to save on taxes. You can save the money you get back at the end of the tax year, rolling it into IRAs or other investments. Or, your tax savings can take place before you ever file your return, by using smart strategies to reduce your taxes in the first place.

When it comes to tax savings, thinking smart in the first place can save you money in the end, as the money you never pay out as taxes in the first place can be used instead to increase your net worth. But because many tax savings only take place the year after you have begun your new investments, it's important to plan ahead.

Tax savings should start at the beginning of the year rather than the end. Take the time to predict what your earnings will be, and calculate the amount you can expect to pay out in taxes by looking at the IRS website and talking with an experienced tax accountant. Depending on the wages you earn and your marital status, you can currently expect to pay out anywhere between 10% and 35% of your gross income in federal taxes excluding the use of deductions or tax sheltered investments.

Tax Savings and IRAs

Certain investment strategies can reduce the total amount of taxes you pay. Individual retirement accounts are set up so that you can invest up to a certain amount of money each year, which is not taxed. Traditional IRAs have a limit of $3,000 (or $3,500 is you were over 50 years old in 2003), and married couples can contribute to an IRA for each person, even if one has little or no income. In a case where only one person is employed, contributing to one's own and one's spouse's IRAs means tax savings on income of between $6,000 and $7,000.

Tax shelters involve investing money in an activity where there is some risk of your losing your investment, such as purchasing rental property. Investing in bonds, buying into a trust, or investing in a business in which you don't participate are also considered "passive" activities, and losses can be deducted for greater tax savings.

Although some have tried to generate tax savings by creating trusts designed to "lose money," generating tax savings by having losses outweigh investments, often by 2:1. The IRS has been cracking down on these corporations, calling them "abusive tax shelters," and penalizing investors and trusts. This year, the IRS offered a limited amnesty to investors in the abusive trust called "Son of Boss" with increasing penalties for those who had not settled by June 21.

Tax Savings and Like Kind Exchanges

In real estate matters, you can create tax savings by trading your property for property of equal or greater value. In this scenario, it is possible to sell a property, then turn the profit into an investment in another property without having to pay capital gains taxes on your profits. It's called "like kind exchange," and can only be used on business or investment property.

Like kind exchanges are subject to strict standards: playing fast and loose with the rules can lose you your tax savings! If you're going to use like kind exchange to create potential tax savings, it's vital that you understand and stick to the rules established by the IRS concerning what constitutes "like kind" and the time frames for the sale and reinvestment in new property.


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