Question

Recommend potential and ethical tax planning opportunities for reducing an individual's tax liability.

Answer 1

1.Some income is not subject to income tax. By earning more tax-free income, a taxpayer can lower their tax liability. You could do this by selling a primary home, investing in bonds, depositing money in a tuition plan for your child's education, opening a health savings account, and taking advantage of certain employer benefits like health/life insurance, disability insurance, dependent care assistance, and educational assistance.

2.Tax deductions reduce taxable income. The amount saved in taxes depends on the taxpayer's tax rate. A taxpayer can either take a standard deduction or can take itemized deductions for medical and dental costs, mortgage points, mortgage interest, property taxes, state income taxes, charitable contributions, and business expenses, among others.

3.As opposed to a tax deduction, a tax credit can lower your taxes dollar for dollar. A tax credit will reduce the amount of taxes you must pay. The government uses tax credits to encourage taxpayers to engage in certain activities or to grant tax relief.

4.Contributions to a 401k retirement account can help lower your taxes by reducing taxable income. The pre-tax money is deposited directly into the 401k account and the growth is tax deferred.

5.Donating to a charitable organization can also lower your taxes. The IRS allows taxpayers to make itemized deductions on their tax return for gifts made to qualified charitable organizations. A taxpayer can deduct donations of money, stock, or noncash contributions and, in some cases, out-of-pocket expenses like transportation costs.

6.If you itemize deductions, deducting medical expenses can lower your taxes. The IRS defines medical expenses as costs incurred for diagnosis, treatment, cure, mitigation, or the prevention of a disease. The taxpayer can deduct medical and dental expenses that exceed 7.5% of their adjusted gross income. Qualified expenses include those for yourself, a spouse, or dependents. Regardless of when the taxpayer incurs the medical costs, the expenses are eligible for deduction in the year paid.

7.A taxpayer can reduce tax liability by benefiting from losses sustained on an investment. To qualify for the deduction, the taxpayer must have taxable gains and losses. The IRS allows taxpayers to use a loss to offset capital gains. If the loss exceeds gains, the taxpayer can deduct the loss against ordinary income. It is permissible to carry over a loss to later years if it exceeds the limit.

8.Shifting income to a child in a lower tax bracket can reduce your income taxes. This is also referred to as splitting income. Shifting income accomplishes two goals: it reduces tax liability and decreases a taxpayer's adjusted gross income.