IRA, or Individual Retirement Arrangement, is a personal savings plan that lets you save up for rainy days and gives you tax benefits in the form of tax deductions. All contributions made to this plan are entitled to the IRA tax deduction. This also includes earnings from these contributions unless they are distributed to you.

There are two types of IRA and therefore two set of rules where deductions are concerned.

The first is the simple IRA. A traditional IRA is a personal savings plan that

encourages you to save for retirement by giving you tax advantages. Contributions that you make to a normal IRA may get you a deduction in part or whole. What you earn on your IRA is also exempt from taxes unless they are distributed to you.

To set up a simple IRA you must be less than seventy and a half years at the end of the tax year in which you have applied. Additionally, you must have a taxable compensation when you set up this plan. Taxable compensation includes: salaries, commissions, alimony, maintenance or any other means of income

generated by self. Rental or any other income from property, annuity or deferred compensation does not qualify as taxable compensation.

The maximum you can contribute to your IRA is either $ 3,000 or your taxable compensation for the year, whichever is less. The contribution limit is $ 3,500 if you are 50 years or older. If at the time of contribution, you are not covered by any other retirement plan, then the whole amount that you contribute is deductible. If, however, you are covered by a valid retirement plan, your IRA deduction can either be reduced or eliminated, depending on the amount of your Modified Adjusted Gross Income and your filing status.

As for withdrawals, anything that you withdraw from IRA is up for taxation, either wholly or in part. If you have been availing of full deduction for contribution made, the taxation on the amount withdrawn will be cent per cent.

A traditional IRA can be established at many different financial institutions, including banks, insurance companies and brokerage firms.

The other type of IRA is the Roth IRA. Roth IRA is the reverse of the traditional IRA. Contributions that you make to this RA will get you no deductions. But, there are no taxes on the withdrawals or earnings either. This exception aside, everything else about Roth IRA is like the simple IRA. Like the latter it can be either an account or an annuity. To be a Roth IRA, the account or annuity must be designated as a Roth IRA when it is set up.

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The standard tax deduction is a safety valve. It reduces the taxable amount by a flat sum. However, you need to see what benefits you more – standard tax deduction or itemised deduction. The latter is available on a range of items like medical expenses, charitable payments, mortgage interest, etc. Under the federal law you can avail only one of the two.

The deduction slabs are usually revised every year so that the tax benefit keeps pace with inflation. The actual deduction, however, varies with the filing status of the individual.

Thus, the standard deduction available to a single individual in 2004 was $4,850; for the head of household it was $7,150; for a married couple filing a joint return it was $9,700; for a qualifying widow(er) with dependent child it was $9,500; and for a married couple filing separate returns it was $4,850.

The law also provides for higher deduction to taxpayers who are more than 65 years old or those who are blind. Those whose spouses are 65 years old or more or blind can also claim a higher deduction.

As against this, those who feature in someone else’s deductions get a lesser deduction. There is a clause for students too: scholarships and grants are considered income and they must keep it in mind while asking for deductions.

The benefit is not available to those who are married but whose spouse itemizes deductions; those who file a tax return for a short tax year because of a change in their annual accounting period; and to those whose status is that of a non-resident or dual-status alien. However, if you are a non-resident alien who is married to a U.S. citizen and choose to be treated as a US resident then you can avail the standard deduction.

The next time you file your returns, take a close look at the standard deduction you are entitled to. It could work better and simpler than the itemized approach.

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A key benefit of buying a home is to get tax deductions on the mortgage interest and the real estate tax. The mortgage tax deduction can be availed as long as the loan amount for the primary residence and second home is less than $1.1 million. This makes this deduction one of the best ways to trim taxes.

An important date in the US home loan calendar is October 14, 1987. All home loans taken before this date are exempt from new rules. A taxpayer can deduct the full interest paid on these loans, regardless of its size and the purpose for what it was used. Similarly, any refinanced debt incurred before October 14, 1987, is rolled into the total acquisition indebtedness.

For those who are new to mortgage tax, acquisition indebtedness is the money that you borrow to buy, build, or improve your home. The tax code is complex when it comes to this debt. Broadly, it lays down that that you can deduct mortgage interest up to an acquisition indebtedness of 1.0 million on all loans taken after October 14, 1987.

The limit for equity indebtedness is $100,000. This means that you can borrow up to $100,000 of the equity in your home and use it for whatever you want. This again is a huge improvement on the pre-1987 years where you could use this money only for home improvements, medical and education expenses

In the past many homeowners refinanced mortgages on their appreciating properties to draw on their equity. They used this sum to buy new cars or take expensive vacations. This benefit has been withdrawn under the new tax laws. Homeowners can no longer make unlimited mortgage interest deductions when drawing on equity.

A second mortgage, or “junior lien”, allows the homeowner to make use of part of the equity that has built up in the home over time. Getting a second mortgage is very much like taking out your first mortgage in terms of closing costs.

The homeowners can also use the use the equity in their home like a credit card. They can borrow against it as and when they need. The lender will charge interest only on the portion of the equity borrowed against. This then becomes the amount on which the homeowner can claim tax deduction.

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Those who are self-employed or are planning to start a business from their home should make full use of the provisions made under the different home business tax deduction heads. These deductions include:

1. Home Office: A home office is that part of the house, which you use solely for your business functions. You can benefit from the home office deduction if you use this office regularly and exclusively for business. Indirect expenses and depreciation too can be deducted.

2. Car: If you use a car to carry out your business then you can deduct the business cost of the car. You can also deduct the operating and maintaining expenses of the car. The deduction can be based on actual costs or the IRS mileage rate, whichever is more beneficial to you.

3. Personal assets: You can claim a deduction on personal assets, like computers, that you use in running your business. You, however, have to qualify the percentage of use.

4. Business Journeys: Costs incurred on air tickets, hotels, internal transportation, shipping and even tipping are tax deductible. When it comes to meals though, you can deduct only half the total amount. The travel expenses of an employer, client or partner are also deductible.

5. Gifts and Entertainment: Being in a business is almost synonymous with having to entertain your clients and customers. Fortunately, 50% of your business-entertainment expense, inclusive of meals and tickets, are tax deductible. Often you may have to lavish gifts on important clients, and in this case the entire cost of the gift is deductible.

6. Retirement: The payments you make when saving for your retirement are deductible from your personal income tax. Thus it follows that the dollars you spend for your retirement plan grow tax free in your business until you retire.

7. Family Connections: Hiring your children as legal employees in your business can allow you to transfer funds in their name. And since children fall in a lower tax bracket they may not have any tax liability. However, only eight-year-olds and above can be hired. Also, the work allocated to them should be such that they can perform it without physical or mental strain. Similarly you can hire your parents as employees thus saving the dollars you spend on taking care of them.

8. Social Security: As a self-employed worker, you have to pay double the social security contribution. Fortunately, half of this contribution is tax deductible in the 1040 form.

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If you have bought a clean fuel vehicle, that is one with a gasoline engine and an electric motor, or one that runs on electricity you can avail a vehicle tax deduction. The former can get you a one-time tax deduction up to $ 2,000 while the latter can fetch you a one-time tax credit up to $ 4,000.

To qualify your vehicle as a clean fuel one, you must make sure that it runs on either of the following fuels: natural gas, LNG, LPG, Hydrogen or any other fuel that is at least 85% alcohol or less. You must remember that even though gasoline/electric hybrids use an electric motor, they are not eligible for electric vehicle tax credits.

Now what if your vehicle runs on dual types of fuel? In that case the cost you incur to convert the car into a clean-fuel user is up for deduction, subject to the stated limits.

There are other requirements as well. To get a tax break on your car, you must buy it first hand and drive it primarily within the USA. The vehicle should have four wheels and must not be used for commercial purposes. If any of the conditions change within 3 years of purchasing the vehicle, some of the money you had saved as tax deduction will have to go.

Now comes the part about vehicle donations. You may have seen several ads that ask you to donate your car and get a tax break. Technically the offer is true. But there are several things you need to consider. You cannot state the value of the car you are donating to be a cent more than its current market price. In effect the amount you can claim deduction for is the amount that a buyer would have paid had you sold it in the fair market.

This is not all. The amount of deduction will depend on the value of the car and how the charitable organization uses it. So, unusual as the situation might be, you will not have an idea about how much of a break your charity is going to fetch you. Also the organization you have donated to, must be recognized by the tax agencies.

Let’s say the charity you gave your vehicle to sold it off at a lower price than your stated value. Then the amount that you get a deduction for is the lower amount. If the charity on the other hand sells your car after using it over a period of time, you need not worry. The value of your car at the time of donation is what matters.

So if you are planning to give a car to charity, go ahead. Some one will benefit and the good part is so will you. The tax collectors will make sure of that.

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If you have set up a day care business in your home, you are eligible for daycare tax deduction. This deduction is valid even if you do not use the premises exclusively for business. What is a care centre by day can well be home by night; and you will still be eligible.

However, it is important to know what qualifies as daycare. When you provide care for children or individuals incapable of looking after themselves because of physical or mental impairments you are in the daycare business. But to run one, you need to have valid certifications or exemptions. If, however, you have had your license revoked or application rejected, you are not eligible to run a daycare centre.

When you run a daycare facility there are certain things you must keep in mind before calculating your deductions. First, you are entitled to deductions related to the premises from where you operate, in this case your home.

You need to find out exactly what portion of your house you use for business and, with what frequency. If you use the premise exclusively for daycare then

you are eligible to deduct all expenses, subject to the stated limits. However, if the usage is part business and part personal then you have to state what

percentage of the total use is for business.

This does not mean that you have to log hours physically and maintain records of the same. Let’s say you run a cr?che for children in your basement, for x hours a day, every weekday. You may use the basement for personal use for the rest of the time, it does not matter; you are eligible to show the time used and claim deductions. If however, you were to use the basement only occasionally for babysitting, you could not claim it as an expense.

Now along with the basement you could well be using another room in your house where children could take a nap. Though the room is unlikely to be used all the time, you need to keep it available through the business day. This room therefore also qualifies as an expense head and is eligible to figure in your

deduction. All expenses related to the maintenance and upkeep of these rooms should figure in your expense list.

If you qualify as a family daycare provider then you can claim deduction on expenses made on providing meals and snacks. If you have employees, you can deduct 100% of their food cost as expense, provided that their salary does not include a food component. If you provide snacks and meals to your wards then to claim deductions you need to maintain records of consumption and show them to be exclusively for the daycare centre. Since your own household is fed from the same kitchen it may be a difficult process to follow. It is advisable therefore to show the standard rate for meals and snacks as expense, and claim deduction.

Standard rates are applicable per person for breakfast, lunch dinner and three snacks per day. These rates include beverages but not non-food material that may be needed to prepare or serve the food. Such utilities, however, can be shown as a separate expense.

So while daycare can be a taxing business, a little care could make sure that the taxes don’t make you feel so. Plan ahead and you could take care of it all!

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Child care tax deduction is a policy that gives you yet another reason to keep your family tree growing. There are many tax savings that you may be entitled to because of your new bundle of joy. Some of the benefits are:

(a) Supplementary exemption called Dependency Exemption
(b) Child Tax Credit
(c) Child and Dependent Care Credit
(d) Tax deduction, by transferring revenue to the child.

(a) Dependency Exemption: This is a form of personal exemption and it reduces your tax bill by subtracting the necessary amount from your gross income directly proportional to the annual inflation. This exemption should meet the following criteria:

* The child (dependent) must be living at your residence throughout the year or he/she must be a relative.

* The dependent’s gross income must not exceed the annual exemption amount. This clause, however, does not apply to children who are less than 19 years of age or are full-time students whose age is less than 24 years.

* The taxpayer must support at least half the dependent’s total cost of living.

* The dependent must be a resident of the US, Mexico or Canada.

If the dependent meets all these rules, then all you need to do is furnish the dependent’s social security number, and you are qualified for another exemption.

(b) Tax Credits: In addition to the personal dependency exemption, there are certain tax credits that may apply to you after your children are born. For instance, you are entitled to Child Tax Credit and Child and Dependent Care Credit. Tax credits are a real advantage because they literally cut the amount of tax you pay on a dollar-for-dollar basis. In cases where the child is adopted, it is even possible for the foster parents to assert tax credits on their income tax for legal adoption expenditure.

(c) Income shifting: Since children fall in a lower tax bracket, it is also possible to save on tax money by transferring funds from the parents to the children. However, care should be taken while doing this. For instance, putting a grown-up’s investment in a child’s name is not permissible.

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Self-employment tax deduction is a blessing for those who run their own business or are planning to set up their business. They can avail several tax benefits on their expenses — benefits that were note available to them when they were working as employees. The self-employed professionals can use their Social Security number as their business tax identification number and file taxes under Schedule C or Schedule C-EZ.

It is important to understand the two schedules, because each provides a different benefit. Form Schedule C-EZ should be used by those whose business expenses are small, who end up the year with a profit, who run the business without any employees, who have no need to claim a home-office deduction and who do not report any depreciation.

Form Schedule C is for business enterprises that are more elaborate. In addition to asking your gross income, you are quizzed in detail about your business expenditure. The main difference between the two forms is that with Schedule C it is possible to report a loss, and make a tax saving.

The following are the tax deductions that you can claim if you are self-employed:

Equipment Expenditure: Section 179 is a deduction that helps you subtract the entire cost of equipment purchased for your business in the same year. This includes costs incurred on purchasing a computer or filing cabinet or any other item relevant to your business requirements. However, there is a limit to this claim. The best place to check the amount is IRS Publication 946 because this amount is changed frequently.

Besides this, your travel (including mileage) and a percentage of meal and entertainment expenses also are deductible. However, to claim these benefits you have to produce receipts and explain the purpose of the expenditure.

Health Insurance and Social Security Taxes: You can avail deductions on health insurance premiums paid for yourself and your family members. Similarly, a part of the payment you make as social security tax can be retrieved from your total income. However, this deduction is available on Form 1040 form and not on Schedule C.

Self-managed retirement benefits: You can open a Keogh or a Simplified Employee Pension plan. The contribution that you make to either of these plans from your earnings can be subtracted from your adjusted gross income when you file Form 1040.

Home Offices: Those of you who use a part of your houses merely for book keeping and file storage can now claim a home office deduction. Now this is possible even if you spend a lot of time doing business outside of your house office.

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If you have been donating to charity you should let the tax agencies know, and avail the charitable tax deduction that becomes legitimately due to you. Your contributions to charitable organizations can add up to a sizeable deduction if you itemize them on IRS Form 1040, Schedule A.

But before you make the donations you must carry out a few checks. You must remember that only donations made to organizations that are recognized by tax agencies are eligible for tax deduction. You can refer to Publication 78 brought out by the IRS that lists all such organizations. This list is available online and in several public libraries too.

You cannot get tax benefits on donations to individuals, political organizations or political leaders nor can you claim benefits for spending time raising money for organizations by holding raffles, bingo or any game of chance.

Tax deduction is also available on contributions made in the form of merchandise, goods or services. However, this deduction can be claimed on the fair market value of these goods or services. For instance, you may decide to make a donation by gifting stocks of your company. In this case the value of the stocks will be calculated as the average of the highest and the lowest traded price on the date of valuation.

You can also donate your car. Its value will be calculated as the resale value at the time of donation. Planes and boats can be donated a well. However, if the claimed value of the donated motor vehicle, boat or plane exceeds $500 and the item is sold by the charitable organization, the taxpayer is limited to the gross proceeds from the sale.

If you are donating a household or personal item then the deduction can be claimed on the amount that the item would have fetched in a garage sale or at a flea shop. All charitable contributions over $250 need a proper receipt to qualify for tax deduction.

You must remember that only contributions actually made during the tax year are up for deduction. If you have used a credit card or issued a check, it does not matter when the transaction shows up in your account. You can seek deduction only in the tax year that you used the instrument.

So go on and keep a list of your generosity. The tax people would appreciate it. So would you.

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The child tax deduction laws can be used to reduce your tax bill by “employing” your kids in your business. Kids here refer to minors between 7 to 17 years of age. Hiring your children not only makes them smarter, but also saves you a lot of tax money!

As a rule, every child has a standard deduction of $4,570; thus it follows that children are exempted from paying the first $4,570 in income. Now, a child hired in your business is paid the amount, which is deducted from your business accounts. The amount can be spent by the child (or by you), and the icing on the cake is that you save $1,425 in taxes (if you are in the 30% tax bracket)

Interestingly, you are cleared from paying social security tax on the “wages” that you pay the child if your child is a minor and if you reimburse them out of a sole proprietorship or partnership. Social security taxes are levied if, and only if, the wages come out of a corporation.

You do have to do some paperwork to avail this benefit. Form 941 is to be submitted four times in a year. This is basically a form used to withhold finances generated by an employee; however, for a child there will be no withholding. Further, at the end of the year, you will have to issue a W-2.

Kids are legally allowed to be hired as employees by their parents when they are 7 years old, provided that the work assigned to them is not mentally and physically challenging, and is within their means to achieve it. The number of hours and the type of assignments completed by the child should be recorded on an Excel Sheet. As long as the pay and the work given to the child are reasonable, you can avail of the tax deduction.

The wages given to your kids do not go into their piggybanks, but into your bank. The money can, and will, be spent only with your approval on the necessary clothes, education, toys, and so on.

Finally, the most important record to keep is to make sure that your kids do not pay for more than 49% of their expenses. Their total expenditure thus needs to be tracked at all times, because if they cross the 50% mark, then you end up losing them as an itemized deduction on your personal return.

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