Income Tax Deductions Issues Research Paper

Abstract

Income tax deductions are important for taxpayers to understand and claim those they qualify for. This study covers: income tax and the most tax systems used i.e. progressive, proportional and regressive; it also discusses what income tax deductions are; the common income tax deductions such as health insurance, license fees, professional association duties, retirement plan contributions student loan interest among others; the most overlooked income tax deductions such as the energy-efficient upgrades, travel to drills and meetings expenses for military reserve and the national guard, etc; conclusions; and recommendations of the study.

Introduction

According to Fishman (2008), income tax is the tax levied on the incomes of businesses both corporations and other legal entities and on the income of individual citizens of a country. Various methods of income taxation are applied i.e. progressive, regressive and proportional. Progressive income taxation in which the rate of tax increases as the amount to be taxed increases; this means the higher the income the higher the tax to be levied. In regressive tax, the tax rate decreases as the income to be taxed increases and proportional taxation is where there is a constant rate of taxation (Steingold & Schroeder, 2007). An individual income tax is levied to the total income of a person on a pay-as-you-earn method with corrections made at end of the year for those who have not made enough payments in the year to the government and refunds to those who have overpaid. Corporate tax is levied directly from the various jurisdictions on the profits of businesses and associations including capital gains. Many countries of the world use a form of income taxation though laws guiding them vary from country to country with most being extremely complex. The critic on taxation is that failure to formulate and implement a balanced income tax can be a discouragement to savings and investment, penalize work and a barrier to business competitiveness.

Income tax deductions issues

An income tax deduction, on the other hand, is the value of an expense that is incurred by the taxpayer and which is allowed to be subtracted from the gross income before figuring the taxes resulting in a lowered total taxable income. A lot of work on taxes goes to determining what deductions to take, how much to take and when to take these deductions. In preparing tax returns it is imperative to understand the basic tax deductions in order to make a good record of them (Steingold & Schroeder, 2007). An expense qualifies to be deductible if it is: ordinary and necessary which means it is common, helpful, accepted and appropriate to the business or the profession; the amount is reasonable, and the expense must be related to the business/profession. Another issue is when to deduct expenses. Some expenses are investments in your life or business and are called capital expenses which are deducted over a number of years other than the year you incur them. Current expenses on the other hand refer to operating costs of the business. These have a useful life of less than one year and are deducted in full the year they are incurred.

Common income tax deductions

Some of the most common items included in income tax deductions include; health insurance, license fees, professional association duties, retirement plan contributions student loan interest, capital losses, business expenses, home mortgage interests, state and local taxes, charitable contributions both cash and non-cash, medical expenses, personal and casualty and theft losses and wages and benefits for employees (Finn, 2008).

Overlooked tax deductions

According to Fishman (2008), there are many income tax deductions overlooked by taxpayers. These include: tax deduction on reinvested dividends is one of the most overlooked subtraction by taxpayers. Mutual funds dividends automatically invested in extra shares increases the tax basis which in turn minimizes the taxable capital gains when you redeem your shares, this means overpaying tax; another item overlooked is the out-of-pocket money used in doing charitable works for instance stamps bought for your school’s fundraiser is charitable work;

A student loan interest paid by the parents is another deductible expense many people are not aware of. When the parents pay the loan and the child is not indicated as a dependant, the money is considered as given to the child to pay the debt. Also if one moves in order to take his/her first job, the expenses incurred in moving oneself and household goods are deductible even without itemizing it yet most people do not know it; travel to drills and meetings expenses for military reserve and the national guard deductions where to qualify you to travel more than 100 miles from home and if staying overnight, lodging and half the meals expenses; Another income tax deduction that people do not know about is the energy-efficient upgrades in the home or the offices for instance windows, doors, insulation and hybrid cars; among others.

Conclusion

Filing tax returns need not be such a hard time even for ordinary people. A person needs to understand the income tax system used in the country and how it affects his/her income. They also need to understand the common income tax deductions and write-offs they have a right to claim. With the help of an expert, a person can also be able to find tax deductions they qualify for and which are mostly ignored or overlooked when filing tax returns.

Recommendations

The first recommendation is to seek information and understand the rules on tax income deductions as contained in the IRS publications on what qualifies to be deducted, Form 1040 schedule A gives a list of items that are tax-deductible. It is also imperative to keep proper documentation of all these expenses and proof in case you are audited. There is a tax filling software for businesses such as Tax Act which benefits the business by advising on the method that will give the most rewards between itemizing and standard deductions. Moreover, it prints out relevant IRS forms for you. It is also important to know when to deduct what expenses from your taxable income this will require you to be able to classify expenses into current expense, capital expense or inventory (Fishman, 2008),

References

1. Fishman, S. (2008) Working for Yourself: Law & Taxes for Independent Contractors,
2. Freelancers & Consultants. Nolo 2008. Web.
3. Finn, D.R (2008). Longterm care insurance and tax planning: make the most of tax rules for premiums and benefits. Journal of Accountancy; 8:14-15.
4. Fishman, S. (2008). Home Business Tax Deductions: Keep What You Earn, Nolo 2008. Web.
5. Steingold, F & Schroeder, A. (2007). The Employer’s Legal. Nolo, 2007.