Free Booklet and Guide: Understanding Taxes

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Free Booklet: Take Control of Your Taxes

It’s been said before that death and taxes are the only two certainties in life.

Clearly, paying taxes is not something most people look forward to. Because of this, you may be tempted to get them over with as quickly as possible: just file your return and move on. 

But familiarizing yourself with current tax law is one of the smartest choices you can make. Being prepared helps you avoid paying more than you have to. This, in turn, helps to keep Uncle Sam from interfering with your long-term financial goals and may help you save a little money for your future.

This year’s tax season officially starts on February 12, 2021. This is when the IRS begins accepting and processing tax returns for 2020. The IRS is encouraging taxpayers to file early, file electronically and use direct deposit for fast refunds. The filing deadline is April 15.1  

The Tax Cuts and Jobs Act of 2017 (TCJA) is set to expire on December 31, 2025, barring further action from Congress. However, most provisions remain in place for 2020. Here are some things you’ll want to know heading into this tax season.

How Do Tax Brackets Work?

The United States has what we call a progressive tax code. That means the more you earn, the higher the tax bracket you’ll fall into. 

Keep in mind that the bracket you’re in doesn’t mean you’ll pay that percentage on your entire income. Instead, a higher tax will be applied to each subsequent block of income, as illustrated in the table below:

Bracket Single

Income over…2

Married filing jointly

Income over…2

Head of Household

Income over…3

10% $0 $0 $0
12% $9,875 $19,750 $14,100
22% $40,125 $80,250 $53,700
24% $85,525 $171,050 $85,500
32% $163,300 $326,600 $163,300
35% $207,350 $414,700 $207,350
37% $518,400 $622,050 $518,400

Tax brackets are also adjusted for inflation each year. The IRS uses what is called a chained consumer price index for all urban consumers, or C-CPI-U, to determine annual adjustments. It assumes that when prices go up on commonly purchased items, shoppers will choose lower priced substitutes. Inflation rises more slowly under this model than under the CPI-U, which measures price increases without considering substitutes. The C-CPI-U method leads more taxpayers to land in higher brackets each year. 

What Are Income Tax Deductions & Credits?

Tax deductions are subtracted from adjusted gross income (AGI). This determines your taxable income, which is the amount you’ll actually owe taxes on. The standard deduction doubled in 2018 following passage of the TCJA. An additional standard deduction is applied to persons 65 and older and to individuals who are legally blind. 

Tax credits are subtracted from the amount of tax you owe after your taxable income is determined. For example, the child credit is $2,000 for each qualifying child. An additional $500 credit is available for other qualifying dependents, such as an elderly parent. These particular credits are not available to single filers earning more than $200,000 per year, or those who are married and filing jointly earning more than $400,000. They also do not adjust for inflation. 

What Can Be Included in Itemized Deductions?

Itemized deductions are expenses that can be subtracted from your AGI, which reduces your taxable income. In most cases, you will either itemize allowable expenses or take the standard deduction.4 Taking the time to fill out these itemized deductions carefully and fully can help you reduce your yearly taxes and save money.

Here are some expenses that can be itemized5:

  • Mortgage interest payments: The IRS caps the mortgage amount on which you can deduct your interest payment. If your mortgage was taken out after December 16, 2017, the cap is $750,000. For mortgages taken out before then, the cap is $1 million. 
  • State and local taxes (SALT): You may deduct the cost of state and local taxes, such as state income taxes and property taxes. Under the TCJA, the SALT deduction is capped at $10,000.
  • Charitable contributions: You may deduct donations to qualified charities totaling up to 60% of your AGI.
  • Medical expenses: Qualified medical expenses may be deducted if they exceed 7.5% of AGI. 

In addition to these deductions, there are other items that may lower your AGI: 

  • Contributions to a traditional IRA
  • Contributions to a health savings account (HSA) or flexible spending account (FSA)
  • Dependent care payments
  • Student loan interest payments
  • Classroom expenses for teachers
  • Self-employment expenses
  • Alimony payments on divorce or separation agreements entered into before 2019
  • Moving expenses for members of the armed forces 

Another deduction known as pass-through income is available for small business owners not organized as a C corporation. These include partnerships, S corporations and sole proprietorships. Qualifying business owners may be able to deduct up to 20% of this income when calculating AGI. 

What Are Some Other Tax Policies I Need to Know About?

In addition to the tax brackets and deductions mentioned above, there are other policies which may affect your tax bill:

  • Alternative minimum tax (AMT): The AMT applies to households whose earnings rise above certain thresholds. For 2020, it applies to $113,400 for married couples filing jointly and $72,900 for individuals. The AMT limits many itemized deductions that are commonly available to lower-income earners.6  
  • 529 college savings plans: Tax- and penalty-free distributions may be used for qualified education expenses up to $10,000, including private school tuition.
  • Retirement plans: The TCJA gives you more time to roll over money defaulted on a loan from a 401(k) or other qualified retirement plan. If you are no longer working for the plan sponsor, you have until the tax return deadline to roll over the defaulted loan.
  • Estate and gift taxes: For 2020, the TCJA increases the estate and generation-skipping exemption to $11.58 million. The tax exemption will go back down to $5 million starting in 2026. The gift tax exemption is $15,000 per person. 

Have More Questions About Your Taxes?

In addition to understanding how tax policy affects you, it’s a good idea to keep taxes in mind when planning your long-term financial strategy. Working with a qualified financial planner can help you build your nest egg while enjoying the tax-efficient savings you are entitled to.

To learn more, we invite you to download The Resource Centers’ free booklet Take Charge of Your Taxes. If you have questions about our wealth management services, reach out online or give us a call at 417-882-1800.

 

Free Booklet: Take Control of Your Taxes

 

Sources: 

1: https://www.irs.gov/newsroom/2021-tax-filing-season-begins-feb-12-irs-outlines-steps-to-speed-refunds-during-pandemic

2: https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2020 

3: https://www.irs.gov/pub/irs-prior/fw4s–2020.pdf 

4: https://www.investopedia.com/terms/i/itemizeddeduction.asp

5: https://www.investopedia.com/articles/taxes/08/itemized-deductions-overview.asp 

6: https://www.thebalance.com/alternative-minimum-tax-amt-who-has-to-pay-3305784 

7: Referenced booklet- “Take Control Of Your Taxes”

The Resource Center is an independent financial services firm that utilizes a variety of investment and insurance products. Investment advisory services offered only by duly registered individuals through AE Wealth Management, LLC (AEWM). AEWM and The Resource Center are not affiliated companies. Neither the firm nor its agents or representatives may give tax or legal advice. Individuals should consult with a qualified professional for guidance before making any purchasing decisions. Information and opinions contained herein that has been obtained from third party sources is believed to be reliable however accuracy and completeness cannot be guaranteed. Our firm is not affiliated with or endorsed by the U.S. Government or any governmental agency. 00827089 02-21

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