The Tax Attic with Jerry Coon — December 23, 2009

Jerry Coon, Enrolled Agent

Jerry Coon, Enrolled Agent

Issues beyond our comprehension

As we near the end of the year, many taxpayers review their financial and tax situations to see if there are any steps that can be taken to reduce their tax bill.

There are multitudes of ways to decrease a tax bill. Many of them I have gone over in the past few weeks, such as paying property taxes by December 31. This will then qualify you to receive a 2009 deduction. That deduction reduces the tax bill by the tax rate of the taxpayer.

For example, a taxpayer in the 25% tax bracket pays a $1,000 property tax bill in December. This payment will save him $250 in taxes, or $1,000 times 25%. That’s how a deduction works.

Your actual tax savings are based on the highest tax bracket of the taxpayer. Our tax system is based on the fundamental that the more income a taxpayer has, the more tax he will pay but the more the deductions are worth. It is an outright fallacy when you hear anything different. The fact is the more income a taxpayer has, the higher will be that taxpayer’s tax bill.

For example, two taxpayers under the age of 65 with no children and filing a joint tax return will pay zero tax on the first $18,700 of income they report. The next $16,700 of income is taxable at 10%. If the taxpayers’ total income was $35,400 ($18,700 plus $16,700), their total tax will be $1,670.

The next highest tax bracket is 15%. The 15% tax bracket extends from the end of the 10% tax bracket at $16,700 all the way up to $67,900 of income, so the next $51,200 is taxed at 15%. If the taxpayers’ total income was $86,600 ($18,700 plus $16,700 plus $51,200), their total tax will be $9,350.

I want to include in this example the 25% tax bracket. The 0%, 10%, 15% and 25% encompass the large majority of all tax returns filed. The 25% tax bracket extends from the end of the 15% tax bracket at $67,900 all the way up to $137,050, so the next $69,150 of income is taxed at 25%. If the taxpayers’ total income was $155,750 ($18,700 plus $16,700 plus $51,200 plus $69,150), their total tax will be $26,637.50. As can be seen, the amount of income tax the person with income of $155,650 incurs, $26,637.50, is much more than the person with income of $86,600, $9,350 of tax, and that is much more than the person with income of $35,400, $1,670 of tax.

Where does this idea come from that the higher income taxpayers pay less than their fair share of tax? I’m not sure where it comes from, but it is not a proper conclusion based on the above facts. In any event, a deduction is indeed worth more to a taxpayer in the 25% tax bracket than it is to the taxpayer in the 10% tax bracket.

There are some year-end moves that can be made that provide a deduction on the federal return and, in addition, provide a credit on the Michigan return. The state of Michigan encourages us to make contributions to several categories of organizations that give us a credit. The federal government also encourages us to make contributions to these organizations, so we are allowed to take a charitable contribution on these same dollars.

The first category Michigan calls “public contributions.” This includes contributions to Michigan colleges or universities, Michigan public libraries, Michigan public broadcasting, some art institutes, and the Michigan Historical Museum. Fifty percent of the contributed amount, up to $100 on a single return and $200 on a joint return, is allowed as a credit on the Michigan return. The gross amount is also allowed as an itemized charitable contribution on the federal return.

Taxpayers filing a joint return make a $400 contribution to a public broadcasting station. This results in a $200 credit on the Michigan return. In addition, let’s say these taxpayers are in the 25% federal tax bracket. This contribution results in an additional $100 of tax savings on the federal return. The net out-of-pocket cost to the taxpayers is $100, because of the combined tax savings.

The second category Michigan calls “Community Foundations.”

The third category Michigan calls “Homeless Shelter/Food Bank Cash Contribution.”

All three of these categories have the same limits, and the limit applies to each category individually. In other words, taxpayers may contribute $400 to a public broadcasting station, $400 to a community foundation, and $400 to a homeless shelter/food bank and receive $200 of credit for each category on the Michigan return and still deduct $400 for each donation on the federal return. This may be the best deal in the world of tax that is available to all of us. This is Jerry Coon signing off. Merry Christmas to all!

Jerry Coon is an Enrolled Agent. He owns Action Tax
Service on Northland Drive in Rockford. He can be
reached through his website at www.actiontaxservice.com.

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