how to maintain our tax bracket

[crabbypatty]

We're in a favorable tax bracket and I want to keep it that way. But DH is going to get an annual raise that may push us out of this bracket. AGI before deductions was less than 1k below the cutoff.

How can we reduce our taxable income? We slightly increased his 401k contribution already this year. I was planning on opening a ROTH, but would a traditional IRA be better for this year? Wouldn't the contribution reduce our taxable income?

I figure it's better to think of this now rather than at tax time next year.

Any suggestions are appreciated. This was the first year I really paid attention to our tax situation so I need all the help I can get.

[sweeps]

Moving into the next tax bracket isn't as bad as it sounds. Just the income that is in that bracket gets taxed at the higher rate.

There are some ways to reduce your taxable income. As you mentioned you could fund a Traditional IRA instead of a Roth IRA, but it may not be to your advantage in the long run. Ultimately it depends on your current income level, your future income level and future tax rates.

You can also switch from, say, taxable money market and bond funds to tax-free money market and bond funds.

But my first point still remains... you don't want to let fear of taxes and tax brackets push you into decisions that will ultimately hurt you in the long run.

[kv968]

Contributing to a traditional IRA would reduce your taxable income by the amount you contribute as long as you fall below the maximum limits to take the deduction. However I wouldn't make the decision of whether to invest in a Roth or a traditional IRA just because an extra $1000 is going to move you into another tax bracket. Moving into another tax bracket doesn't mean your entire income is then going to be taxed at that rate. For instance, if that $1000 puts you in the 28% tax bracket, only that $1000 will be tax at that rate. The rest will be taxed accordingly to the rates attached to each income level as you progress through them. I don't know if I explained that very well but take a look at this Tax Brackets and maybe that will help.

[crabbypatty]

I didnt realize that only the amount above the limit is taxed at the higher rate. That makes it a whole different story. You're both right, it isn't something that should change my overall plan.

Thanks

[kv968]

Originally Posted by crabbypatty

I didnt realize that only the amount above the limit is taxed at the higher rate. That makes it a whole different story. You're both right, it isn't something that should change my overall plan.

Thanks

You're welcome. And just my opinion...I'd stick with the Roth

[jIM_Ohio]

Originally Posted by crabbypatty

We're in a favorable tax bracket and I want to keep it that way. But DH is going to get an annual raise that may push us out of this bracket. AGI before deductions was less than 1k below the cutoff.

How can we reduce our taxable income? We slightly increased his 401k contribution already this year. I was planning on opening a ROTH, but would a traditional IRA be better for this year? Wouldn't the contribution reduce our taxable income?

I figure it's better to think of this now rather than at tax time next year.

Any suggestions are appreciated. This was the first year I really paid attention to our tax situation so I need all the help I can get.

first thing would be understand tax brackets.

Tax Brackets (Federal Income Tax Rates) 2000 through 2006

open link ina new window and make sure it's set to maried filing jointly for 2006.

Let's assume you are in 15% tax bracket (income less than 61.3k, I'll use 61k for the example) and about to move to higher tax bracket (25% at $61,300).

The 3 tax rates are:

10% tax paid on first $15,100 ($1510 total tax)
15% tax paid on difference of 61k (income) and 15,100 (you already paid tax on this at 10%) 61,000-15100=45,900*15%=$6885.

Your "total tax" is $6885+$1510=$8395.

Assume person (family) above gets a 5k raise. to 66k.

They would owe another $300*15%=$45. This caps out 15% bracket.

66,000-61,300=4700 is income which has not been taxed (yet).

$4700*25%=$1175.

Now the total tax owed is $1175+$6885+$1510=$9570 total tax owed.

If you make 66k, the whole income is NOT taxed at same rate. Whether a person makes 10k, 45k, 75k or 195k, the first $15,100 is all taxed at 10%... even though the highest dollar in each case is taxed at a different rate.

I am an engineer and know the math, but any tax accountant is more than welcome to correct errors.

thx

jIM

[lucasrd]

That's what happens when you make more $$. I'd rather make more money than be in a lower tax bracket and make less.

[crabbypatty]

Originally Posted by lucasrd

That's what happens when you make more $$. I'd rather make more money than be in a lower tax bracket and make less.

Well, yeah I agree. But I completely misunderstood how we are taxed. If the full amount was taxed 10 percent higher and you were only over the bracket by a few hundred dollars, you might look for ways to reduce that taxable income.

[MonkeyMama]

See you got a lot of good advice already. Do you have a mortgage? Something else you can consider, if not. BUT of course there is a lot more to smart financial decisions that tax factors, as said above.

I just wanted to say too you may be surprised. Tax bracket is based on your income - deductions. We had an extra $20k income last year from ROTH conversion and we were still in the 15% bracket (though barely) - I was pretty surprised.

Since I am a nerdy accountant I have a nifty little federal and tax rate schedule thing I carry in my wallet - can't tell you how much I reference it - whenever my dh talks getting a job I have to look at it - tell him how much he can make. I am more worried about AMT and also since he deosn't work now would make a huge difference with payroll taxes and such.

But anyway, you may be surprised, may stay in the same bracket?

[jIM_Ohio]

I have always wondered what would "trigger" AMT. That denies Roth eligibility and many other common tax deductions. Care to comment?

[crabbypatty]

aack a new term. What's AMT?

[kv968]

Originally Posted by jIM_Ohio

I have always wondered what would "trigger" AMT. That denies Roth eligibility and many other common tax deductions. Care to comment?

I think what triggers it is one of the "great mysteries" of the IRS. It seems as if having a lot of write-offs and high income can trigger it. I that the big problem is that the "high income" isn't indexed to inflation so what was considered high when the ATM was devised, isn't considered that "high" now.

If MonkeyMama's worried about it in a 15% bracket I'm starting to get worried myself. Unless of course she should be in a much higher bracket but due to deductions she dropped down to that. MoneyMama?

I've also heard that exercising a decent amount of stock options could be a trigger. Who knows when dealing with the gov't when they want more money

[kv968]

Originally Posted by crabbypatty

aack a new term. What's AMT?

Alternative Minimum Tax

[MonkeyMama]

Oh it is very long and complicated. See my link below...

JimOhio - the most interesting this is we are in the 15% tax bracket (big mortgage - high COL area - high state taxes (and therefore deductions) and kids - if my hubby made $20k we would go fromn 15% tax bracket (We are nowhere even close to 25%!) to AMT - just pure craziness. I am sure Congress will do quick fix this year - probably through this presidency. PAss it off to the next administration...

It is mostly triggered by having kids and living in a coastal state, owning a home. BAsically the basics that will affect the most people - will disallow state tax deductions (huge in california and NY with high property tax and state income taxes), disallows personal exemptions too (why affects people with kids more). Then you pay a high flat tax (vs. current tiered rates).

We have dealt with this for years with our upper-middle-class tax clients. The sad thing is this "tax on the wealthy" has been hitting hard the $100k-$500k income range in high COL Areas. Say you make $300k here, give well over 1/2 to the government, slammed by AMT in addition, $150k left per year does not buy the same lifestyle here that it does in Kansas. So it has been pretty ugly over here.

By 2010 this will start hitting a large percent of people in these areas who make $75k. Yes the filthy rich (that's sarcasm!!). You know you can't even buy a little bitty condo for less than $500k but you are taxed out the ears on your money so lose lose. It really spells disaster for certain areas of the country.

Tax Policy Center | Publications

[jIM_Ohio]

Originally Posted by kv968

I think what triggers it is one of the "great mysteries" of the IRS. It seems as if having a lot of write-offs and high income can trigger it. I that the big problem is that the "high income" isn't indexed to inflation so what was considered high when the ATM was devised, isn't considered that "high" now.

If MonkeyMama's worried about it in a 15% bracket I'm starting to get worried myself. Unless of course she should be in a much higher bracket but due to deductions she dropped down to that. MoneyMama?

I've also heard that exercising a decent amount of stock options could be a trigger. Who knows when dealing with the gov't when they want more money

I heard about the stock options one...

I heard a few key deductions also trigger it. Is mortgage interest still deductable under AMT?

[MonkeyMama]

Originally Posted by kv968

I

If MonkeyMama's worried about it in a 15% bracket I'm starting to get worried myself. Unless of course she should be in a much higher bracket but due to deductions she dropped down to that. MoneyMama?

Yes, if congress doesn't do the quick fix this year I would be worried... But they will most likely.

I tell my dh every year no point for him to work until they fix it - last year they took until June or something to pass the quick fix - who knows how long they will take this year...

I should have said hits 2-income families very heavily - obviously I guess - since means more income. Add that to the 2-income trap.

[kv968]

Originally Posted by jIM_Ohio

I heard about the stock options one...

I heard a few key deductions also trigger it. Is mortgage interest still deductable under AMT?

I believe mortgage interest is still allowed but I don't think you can deduct home-equity loan interest unless it's used for home improvements. Someone please correct me if I'm wrong.

[MonkeyMama]

Originally Posted by jIM_Ohio

I heard about the stock options one...

I heard a few key deductions also trigger it. Is mortgage interest still deductable under AMT?

mortgage interest is (phew) but not the home equity portion. If you borrow up to $100k against your home, under regular tax, it is deductible - equity interest.

Under AMT, only the part used to purchase a home is deductible, equity portion is not. The simplified answer...

[MonkeyMama]

Originally Posted by kv968

I believe mortgage interest is still allowed but I don't think you can deduct home-equity loan interest unless it's used for home improvements. Someone please correct me if I'm wrong.

I think you are right - home improvements okay.

[MonkeyMama]

Me and my big mouth - sorry to hijack the thread. I have been meaning to do either an article or blog on AMT - most people have never really heard of it, and well, it is a big cause of mine - to educate people. We need more people outraged now than before they get blindsided one year buy this surprise. I am more worried about 2010 than today, but the more we complain to congress now the more likely it will get fixed.

Stock options is another huge AMT issue which has never really been fixed either.

AMT was originally a tax on the extremely wealthy, so they could not avoid taxes, but has not been indexed for inflation and is quickly hitting the non-wealthy. IT is greatly magnified by the Bush Tax Cuts,mostly because the gap between the regular tax and AMT has widened considerably. Before bush Tax cuts, my taxes would not be nearly so LOW as they are now - just makes it that much more shocking I guess...