Tuesday, December 06, 2005

Taxes by the numbers

I've always been one to do my own taxes...this is probably largely due to my dad always doing his taxes. Since graduating there has been a number of tax laws and income cut-offs that I've had to become more aware of as my own personal income level has increased. Some of these cut-offs can have substantial tax break implications if you are aware of them and may cause you to handle your investments differently. The two I've found most crucial relates to the AMT and allowable contributions to Roth IRAs.

Roth IRAs (<$110,000 single, <$160,000 married)

If you don't know what these are, they are really something you should look into investing in as soon as you get a job. Motley Fool has a good summation of how or when you should start investing. Even if you have a 401k or other retirement account, you can benefit from Roth IRAs by having a second place to pull money from during retirement to help keep your overall taxable income down, not to mention that all gains are tax free. Pulling from just a 401k would mean all the money for living expenses is taxable, but money you pull from a Roth is not taxable. Combine that with other investments and your overall taxable income during retirement can be kept fairly low. The Roth is also useable for first-time home buyers, so there's very good reasons to start investing as soon as possible. The crucial modified adjusted gross income (MAGI) numbers to keep in mind for eligibility is below $95,000-$110,000 for single and below $150,000-$160,000 for married filing joint. You really don't want to go the married filing seperately route since the phaseout is from $0-$10,000.

Alternative Minimum Tax ($112,500 single, $150,000 married)

The AMT is something I have traditionally glossed over up until last year when I went through computing it and discovered I was having to pay more money. One major problem I have with this little gem is that I always itemize deductions and add the large NYS income taxes as well as property and school taxes. The AMT however has no deduction for such taxes which happen to be quite large in NY. So it seems the Fed wants the money we paid NYS to be taxed. The goverment has identified this as being a problem (CBO article) and perhaps something will be done for 2006 and beyond. I'm still hopeful, but it does mean I may consider doing a few things differently if not. It's difficult to know if you will be affected until you actually do the calculations, but the higher your state and local tax payments are and the closer you are to $112,500 for single and $150,000 for married filing jointly the more likely it seems it will affect you. Here's a few articles you might find interesting:
AMT 101
AMT: What Is It and Why Should You Care?
AMT Estimator

If you are approaching the above limits, you should probably first look at maxing your 401k contribution for the year if you haven't already done so. You might also want to hold off on some capital gains or even allow for a capital loss (max $3000) to restructure your portfolio. You could also switch your savings or money market funds to a tax-exempt money market or go with some tax-exempt bonds or perhaps something like i-bonds if a long-term bond seems a bit risky right now to avoid increasing your taxable income for the year.


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