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Guide to Tax Law
- Introduction to Tax Law
- What is the IRS?
- Filing Your Tax Return
- Rights of Tax Payers
- What is a Tax Credit?
- Tax Implications of Differed Income
- How Tax Deductions Work
- Recucing Your Taxes with Investments
- Tax Benefits for Homeowners
- Shifting Income withing a Household
- Your Status as a Tax Payer
- Small Business Owners and the IRS
- Minimize Taxes on Your Estate
- Tax Fraud and other Crimes
- Red Flag: IRS Audits
- Taking Your Case to Tax Court
- What if Your Owe the IRS?
- When to Hire a Tax Attorney
Tax Free Income refers to certain types of income that are not subject to taxation by the Federal Government. Examples of Federal tax free income include (but are limited to):
- Interest earned on state-issued bonds or bonds issued by a territory or municipality. Commonly, these type of bonds are called municipal bonds and in addition to earning tax free interest, bond holders also enjoy an increased bond value as the taxpayer's marginal tax rate increases.
- Money reimbursed to a taxpayer by members of a carpool to and from work.
- Up to $250,000 tax free income from the sale of a home, provided the applicable provisions are satisfied.
- Up to $5,250 per year of tax free tuition reimbursement from the employer of a taxpayer.
- Discounted parking, discounted public transportation cards and passes are tax-free up to the allowable discount rate.
Capital Gains From Selling Your Home
In addition to the tax benefits of owning a home, there are multiple benefits extended to homeowners who choose to sell their home.
Home Sale Tax Exclusion
In order to qualify for the home sale exclusion, the taxpayer must have owned and used the property as their main residence for at least two of the past five years. Under the home sale exclusion, individuals can avoid federal income taxes on gains of up to $250,000, and married couples who file jointly can exclude up to $500,000.
If a home was sold because of a job, health considerations or certain unforeseen circumstances (i.e. divorce or separation), the taxpayer may qualify for a prorated gain exclusion.
Generally, the prorated exclusion will be enough to shelter the entire gain of an individual.
College Saving
Coverdell ESA and 529 plans
Coverdell ESA: In 2002, the savings plan formerly knows as an Education IRA was revamped and renamed to what is now known as a Coverdell Education Savings Account ("ESA").
An ESA differs from a 529 Savings Plan in that some of the provisions of the ESA are more restrictive. For example, an ESA only allows investments toward education to be tax-free up until the beneficiary of the account reached 18 years of age. With a 529 plan, there is a lifetime maximum amount that can be contributed tax-free, but not an age limit.
Additionally, the total yearly contribution to an ESA per child is limited to $2,000. Any contributions, whether contributed by parents or other family members, will be subject to a tax penalty under the ESA regulations.
529 Plans
A 529 College Savings Plan is a tax-advantaged savings plan that is sponsored by the state. A 529 College Savings Plan allows families and students to save money for covering the costs of education and education-related expenses. Among the benefits of 529 plans are provisions that allow tax-deferred growth and that are free from federal income tax when applied toward qualified education or education expenses. withdrawals when used for qualified education expenses.
The Pension Protection Act of 2006 codified the tax benefits of 529 Savings Plans and increased the tax benefits to include tax-free savings of gifts and estate transactions. 529 Savings Plans allow for small contributions of $15 or $25 at a time and have very limited management and account fees.
There is a lifetime maximum account balance of around $300,000 for most states, and most plans allow for liquidity and withdrawals of funds within ten days after they are invested.
Other Tax Free Education Options
Other tax free education options include certain education tax credits and government grants and scholarships.
Examples of Federal tax-free education programs include The Hope Scholarship credit (allowing a maximum $1,800 tax-free for 2008), which is available to students during their first two years of college.
Another option for tax-free education money is the Lifetime Learning credit (maximum $2,000) can be used at any time and doesn't have a degree or workload requirement.
Tax Free Investments
There are many different types of structured savings accounts and state-issued bonds that are incentivized by their tax-free status. Examples of tax-free investments include, but are not limited to: bonds, Roth IRA's and 401K's.
Bonds
Interest earned on state-issued bonds or bonds issued by a territory or municipality often yield tax-free earnings for investors who purchase the bonds. Commonly, these type of bonds are called municipal bonds, or "munis" and in addition to earning tax free interest, bond holders also enjoy an increased bond value as the taxpayer's marginal tax rate increases.
General Obligation Municipal Bonds, which are insured by the issuer's (usually the state) ability to pay back the value plus earned interest in the future.
Revenue Municipal Bonds are backed by the government-sanctioned business (i.e. the public waterworks of a state) that issues the bonds and pays interest from earnings of the business.
Roth IRA and 401k
In the 2008 tax year, individuals were able to contribute more to Roth IRA's than ever before. This increased allowable contribution gave a greater number of people a much better chance of making a meaningful tax-saving deductible contribution.
With traditional IRA's, individuals who reached the age of 70 �, could no longer contribute to the IRA. However, individuals over 70 � can still contribute to a Roth IRA as long as the person making the contribution had earned income at least equal to what was contributed.
In 2008, Roth contributions phased out between AGI of $101,000 and $116,000 for unmarried taxpayers. For joint filers, the range is between $159,000 and $169,000. These ranges are significantly higher than just a couple of years ago. Whether an individual is covered by a retirement plan (or not) has zero impact on eligibility to make Roth IRA contributions.
The deadline to make a Roth IRA contribution for the 2008 tax year was April 15.
Other Tax Free Investments
Other tax-free investments include, but are not limited to:
- US Treasury securities, such as Treasury Bills and Treasury Bonds, in which the interest is tax-free subject to federal income tax regulations; and
- United States Savings Bonds, which are subject to Federal income tax but are exempt form state and local taxation.