Finance and AccountingTaxation
Summary of KPMG’s “Individual Income Tax” (2021 Edition)
Introduction
KPMG’s “Individual Income Tax” is a comprehensive guide tailored for individuals seeking to understand and manage their income tax obligations efficiently. The 2021 edition addresses changes relevant to that tax year and provides practical advice for taxpayers navigating through complex tax regulations. The book covers a broad range of topics, including tax deductions, credits, filing requirements, and planning strategies, accompanied by numerous actionable tips and examples.
1. Filing Status
Key Points
- Filing Status Types: The book identifies five main types of filing status – Single, Married Filing Jointly, Married Filing Separately, Head of Household, and Qualifying Widow(er) with Dependent Child.
- Impact on Tax Rates: Your filing status significantly impacts your tax rates, standard deductions, and eligibility for various credits and deductions.
Actions
- Evaluate Your Status: Review your personal situation annually to determine your appropriate filing status by December 31st of the tax year.
Example
An unmarried individual supporting a dependent can file as Head of Household, which may result in a lower tax rate and a higher standard deduction compared to Single.
2. Gross Income
Key Points
- Inclusion of Income: All income from whatever source derived, unless specifically excluded by law, must be included in gross income.
- Common Sources: Wages, interest, dividends, capital gains, and retirement benefits.
- Exclusions: Gifts, inheritances, and specific employee fringe benefits like health insurance.
Actions
- Track All Income: Maintain thorough records of all sources of income, and understand which income is taxable versus non-taxable.
Example
If you receive a gift of $20,000 from a family member, it is excluded from gross income and not subject to income tax.
3. Adjusted Gross Income (AGI)
Key Points
- AGI Calculation: Gross income minus specific deductions, such as contributions to retirement accounts or student loan interest.
- Importance of AGI: Many tax benefits, credits, and additional taxes are determined based on your AGI.
Actions
- Maximize Deductions: Contribute to retirement plans (like a 401(k) or IRA) and take advantage of above-the-line deductions to lower your AGI.
Example
Contributing $6,000 to a traditional IRA can reduce your AGI, which may increase your eligibility for additional tax credits and deductions.
4. Tax Credits and Deductions
Key Points
- Difference between Credits and Deductions: Credits directly reduce the tax owed, while deductions reduce the amount of income that is subject to tax.
- Common Deductions: Mortgage interest, state taxes, and charitable contributions.
- Common Credits: Earned Income Tax Credit (EITC), Child Tax Credit, and education credits.
Actions
- Itemize or Standardize: Decide annually whether to itemize deductions or take the standard deduction based on which option will lower your tax liability more.
- Claim Eligible Credits: Research and claim all credits for which you are eligible.
Example
If your qualifying educational expenses are $4,000, you might be eligible for the American Opportunity Tax Credit, which could provide a credit up to $2,500.
5. Retirement Savings and Planning
Key Points
- Tax-Advantaged Accounts: 401(k)s, IRAs, Roth IRAs, and HSAs offer different tax benefits and planning opportunities.
- Required Minimum Distributions (RMDs): Withdrawals that must begin at age 72 for most retirement accounts.
Actions
- Contribute Strategically: Make consistent contributions to retirement accounts to benefit from tax-deferred or tax-free growth.
- Plan for RMDs: Prepare for RMDs to avoid penalties, and consider converting portions of a traditional IRA to a Roth IRA where appropriate.
Example
Contributing to a Roth IRA, where contributions are made with after-tax dollars but withdrawals are tax-free, can be beneficial for long-term tax planning.
6. Self-Employment and Business Income
Key Points
- Self-Employment Taxes: Self-employed individuals must pay both the employer and employee portions of Social Security and Medicare taxes.
- Business Deductions: Expenses that are ordinary and necessary for conducting business, such as home office expenses, can be deducted.
Actions
- Track Expenses: Maintain accurate records of all business-related expenses to maximize deductions.
- Estimated Payments: Make quarterly estimated tax payments to avoid underpayment penalties.
Example
A freelancer can deduct home office expenses, such as a portion of rent and utilities, if the home office is used exclusively for business.
7. Investment Income and Capital Gains
Key Points
- Types of Investment Income: Interest, dividends, and capital gains are the primary types of investment income.
- Tax Rates on Capital Gains: Long-term capital gains are taxed at lower rates compared to short-term gains, which are taxed as ordinary income.
Actions
- Hold Investments: If possible, hold investments for more than a year to qualify for the lower long-term capital gains tax rate.
- Harvest Losses: Use tax-loss harvesting to offset capital gains with losses, thereby reducing taxable income.
Example
Selling a stock at a loss to offset a gain from another investment can reduce your overall capital gains liability.
8. Tax Planning Strategies
Key Points
- Tax Deferral: Postpone recognizing income to a future year to defer tax liabilities.
- Tax-Free Exchanges: Utilize benefits like 1031 exchanges for real estate to defer tax on capital gains.
Actions
- Defer Income: Timing bonuses, stock options, or other discretionary income to future years can minimize current year taxes.
- Leverage Tax-Free Opportunities: Engage in like-kind exchanges for investment properties to defer capital gains tax.
Example
A real estate investor can defer capital gains tax by reinvesting proceeds from the sale of a property into a like-kind property through a 1031 exchange.
Conclusion
KPMG’s “Individual Income Tax” provides readers with detailed insights into managing their tax obligations, maximizing deductions and credits, and strategically planning for future tax events. By understanding and utilizing the specific advice provided in the book, individuals can make informed decisions that optimize their tax positions and potentially result in significant tax savings.
Every taxpayer is encouraged to stay informed about changes in tax laws and seek professional consultation when necessary. Implementing the strategies discussed in the book can lead to more effective tax management and better financial outcomes.
Final Actionable Tips:
- Regularly Review Financial Status: Conduct an annual review of your financial situation concerning taxes.
- Stay Updated: Keep abreast of tax law changes that could impact your tax filings and strategies.
- Consult Professionals: When in doubt, consult with a tax advisor or accountant for personalized advice and planning assistance.