Before you begin your tax return, it helps to get organized and have a well thought out plan.
Many people think that the amount of income tax they pay is determined by the amount of their taxable income. The truth is that people with exactly the same amount of taxable income can end up with different tax bills, depending on their filing status. Each filing status has its own tax brackets, and your filing status also affects how other tax rules, such as the standard deduction, IRA contribution limits, and tax credits and deductions, apply to you.
Filing Status
There are five categories of filing status: married filing jointly; married filing separately; single; head of household and qualifying widow(er). The primary factor impacting your filing status is whether you are married or not. If you are married, you and your spouse must decide whether to file jointly or separately. In most cases, you'll pay lower taxes if you file jointly and you can take advantage of tax credits and benefits that aren't available to couples who file separately.
Separate returns can be advantageous in some situations, such as when one spouse has high unreimbursed medical expenses or many miscellaneous itemized deductions. In some cases, you may be able to deduct a higher percentage of these expenses by filing separately. The only way to be sure is to compute your taxes both ways. You should also give serious thought to filing separately if you suspect your spouse of tax fraud.
If you are not married, you can use the single filing status or the head-of-household filing status. Heads of household pay a significantly lower tax rate than singles, but to qualify, you must meet the requirement for supporting at least one other dependent.
If you are a qualifying widow(er), you may use the joint tax rates for two years following the year of death of your spouse, as long as (1) you have a qualifying dependent, (2) you provide more than half the cost of keeping up a home for you and your dependent and (3) you did not remarry.
2007 Tax Rates
The tax rates remain the same as last year. The six tax brackets are 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. The tax rates are scheduled to remain the same until 2011, when the higher pre-2001 tax rates will return.
Standard Deduction
Now let's talk about the standard deduction, the basic deduction all taxpayers can take. Every year, the Internal Revenue Service adjusts the standard deduction to account for inflation. For 2007, the standard deduction is $5,350 for single filers or married couples filing separately. The standard deduction jumps to $10,700 for married couples filing jointly and for qualifying widow(er)s, and to $7,850 for head-of-household filers. The standard deduction is higher for blind taxpayers and those age 65 or older.
Standard Deduction
Taxpayers 65 and older and/or blind get an additional standard deduction amount that is added to the standard deduction.
Married (filing jointly or separately) - $1,050
Single or head of household - $1,300
An individual who is both over 65 and blind may take two additional standard deductions. Married taxpayers filing jointly, both of whom are over age 65 and blind, would be able to claim four additional standard deduction amounts.
Itemizing Deductions
An alternative to claiming the standard deduction is itemizing your deductions. To determine the best strategy for you, total all of your deductions. If your total itemized deductions are greater than the standard deduction, by all means, itemize. It will save you money. High income taxpayers need to know that their allowable itemized deductions may be reduced if Adjusted Gross Income, or AGI, is over $156,400 for single, head of household, and married taxpayers filing jointly, or $78,200 for married couples filing separately. Once AGI reaches these levels, itemized deductions are reduced.
The good news is that the deduction limit is being phased out so the amount you will lose is less than last year. For years beginning after 2009, the itemized deduction limit will be fully repealed.
Here's another tip: If you find you're getting close to exceeding the standard deduction limit, try bunching your tax breaks every other year. This allows you to claim the standard deduction one year, but itemize the next. For example, instead of writing a $500 check every December to your favorite charity, write one $1,000 check every other year.
Personal Exemption
In addition to the standard or itemized deductions, you can also subtract personal exemptions from your adjusted gross income to arrive at taxable income. In addition to personal exemptions for you and your spouse, you can claim a personal exemption for each dependent. The amount you can deduct for each exemption increases from $3,300 in 2006 to $3,400 in 2007. However, you will lose part of the benefit of your exemptions if your AGI is above a certain amount. For 2007, if your adjusted gross income exceeds the maximum phase-out amount, your exemption amount is $1,133. The amount at which the phase-out begins depends on your filing status. Again, this exemption reduction is being phased out. In 2010, there will be no phase-out of exemptions.
Article provided by the Massachusetts Society of Certified Public Accountants.
