Personal Tax Planning

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  • 0:02 What Are Income Taxes?
  • 1:14 Itemized Deductions
  • 2:41 Home Office Deduction
  • 3:38 Flexible Spending Accounts
  • 4:36 Retirement Contributions
  • 5:26 Lesson Summary
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Lesson Transcript
Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, we'll discuss income tax and its purpose. You'll also learn how to reduce your tax liability with itemized deductions, flexible spending accounts, home office expenses and retirement contributions.

What Are Income Taxes?

Arriana works for her state's department of banking, which promoted a handful employees to senior financial examiner at the start of 2015. Arriana was one of the lucky few. Her salary increased from $55,000 to $75,000, but what she didn't realize was that her income tax liability, the tax amount owed to the government, would also increase substantially. Income tax is a percentage of income levied, or imposed, by the government to pay for federal services and programs. U.S. tax liabilities are based on a graduated system, and so an increase in income will increase your tax liability, as is the case for Arriana.

The government agency that manages the U.S. tax system is the Internal Revenue Service (IRS). The IRS not only collects taxes, but it also creates tax laws and codes that allow for deductions, which are expenses excluded from taxable income to help reduce tax liability. To better understand these concepts and get help with personal tax planning for when she files for the year 2015, Arriana decides to visit a tax professional, Mr. Juarez.

Itemized Deductions

After a quick review of Arriana's prior year return, Mr. Juarez notices that she used a standard deduction for 2014. A standard deduction is the standard amount the IRS allows taxpayers to deduct from their income based on filing status. For 2015, the standard deduction for a single person was $6,300. This amount applies to 2015 and would be used when preparing taxes by April 2016.

The standard deduction means you don't have to itemize each deduction separately. However, if your deductions are more than the standard - more than $6,300 for 2015 - then you would want to itemize your deductions to get the lowest tax payment possible, or the highest tax return.

Itemized deductions allow tax payers to reduce their income by claiming the following on Schedule A of Form 1040:

  • Mortgage interest and property taxes
  • Charitable contributions
  • Medical expenses
  • Casualty and theft losses
  • Job losses

Some of the items may have limits or other stipulations, so it's best to understand the tax code. Nevertheless, the IRS allows taxpayers to claim standard deductions or itemized deductions, whichever provides a greater tax benefit. Mr. Juarez suggests that, since Arriana's charity contributions, medical expenses and other deductions are more than the standard, she should itemize her deductions for 2015.

Home Office Deduction

Another allowable reduction in income is home office expenses. Arriana is allowed to work from home two days out of the week, so Mr. Juarez explains that she may be able to use the cost of running her home office as a deduction.

There are strict rules about using the home office deduction. The home office must be your primary place of business, or it must pass the regular use test, which ensures that the space is used on a regular basis and only for work. Let's say Arriana uses her spare room as her office, and it measures 150 square feet, which is 10 percent of her 1,500-square-foot home. She could claim 10% of the all related household expenses, such as utilities and rent, to reduce her tax liability.

Note that, in general, many out-of-pocket expenses that go toward working are tax deductible. In addition to home office expenses, you might deduct the cost of commuting, business travel, computers and so forth.

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