By: Yara Zakharia, Esq., Contributing Editor
Let's face it, taxes can be quite taxing. With the help of tax deduction, however, a considerable weight can be taken off taxpayers' pocketbooks. Since the IRS collects only on an individual's taxable income, taxpayers can cut their tax bills by lowering their taxable income through the mechanism of a tax deduction. What follows is a discussion of tax deduction basics as well as tax debt relief and tax debt settlement options.
What is a tax deduction?
A tax deduction is the amount subtracted from the taxable income, thus resulting in a lower tax liability. The larger the tax deduction, the smaller the tax liability. A tax deduction comes in two forms- standard and itemized. Taxpayers utilize the larger of the two deductions to reduce their taxable income.
What is a standard deduction?
A standard deduction is the fixed amount that taxpayers may deduct from their adjusted gross income (AGI) to compute taxable income. With this method, taxpayers need not record each potential tax-deductible expense throughout the year. The amount of the standard deduction depends on the taxpayer's filing status and the number of dependents he or she has. Most taxpayers use this type of tax deduction, which can be claimed on one of three individual tax returns- 1040, 1040A or 1040EZ.
For 2007, individuals filing a single tax return took a standard tax deduction of $5,350. Married persons filing a joint return, or a qualifying widow or widower with a dependent child, took a standard tax deduction of $10,700. Married persons filing a separate return took a standard deduction of $5,350, and individuals filing as head of household received a standard deduction of $7,850.
Who does not qualify for a standard deduction?
- An taxpayer who is married and filing a separate return, and whose spouse itemizes deductions
- An individual filing a tax return for less than a 12-month period, and
- An individual who was a non-resident during the tax year, or was both a non-resident and a resident alien during the tax year.
What is an itemized deduction?
Filers who do not qualify for this type of tax deduction will have to itemize. A taxpayer makes an itemized deduction if the amount of his allowable deductions is greater than his standard deduction. The taxpayer must complete the IRS form 1040 and Schedule A. Itemized deductions begin phasing out at higher incomes. For this kind of tax deduction, tracking costs by collecting receipts and recording the expenses is recommended.
Some of the categories where itemized deductions apply are:
- Home mortgage interest
- Real estate taxes
- State and local taxes
- Personal property taxes (i.e. car registration fees)
- Investment-related expenses
- Medical and dental expenses
- Tax preparation fees
- Contribution to charitable organizations
- Miscellaneous expenses (job-related expenses such as travel, lodging and meals)
What is tax debt settlement?
Tax debt settlement is a method of addressing problem debts without having to file for bankruptcy. Creditors agree to accept a percentage of the amount owed by a taxpayer (usually around 50% or less) to settle the account, and the remaining balance is forgiven. IRS tax debt settlement is available to individuals who find themselves indebted to the IRS.
What tax debt relief methods are available to debtors?
Debtors can avail themselves of the following five strategies for IRS tax debt relief:
- Installment agreement
- Partial payment installment agreement
- Offer in compromise (i.e., making a lump sum or short term payment to pay of the IRS at a reduced dollar amount)
- Not currently collectible, whereby the IRS voluntarily agrees not to collect on a tax debt for a year or so, and
- Filing for bankruptcy (i.e. discharging tax debts by way of a Chapter 7 or Chapter 13 bankruptcy petition)
In conclusion, when it comes to taxes, there may be no free lunch but there are discounts. A tax deduction, be it standard or itemized, is the mechanism by which taxpayers can reduce their tax bill. As for taxpayers who owe money to the IRS, they need not despair, for tax debt relief measures and tax debt settlement are at their disposal.
