Taxes 2006 For Dummies

Move extra savings out of the bank. Keeping your household checking account at the local bank is fine, but you're generally throwing away free interest if you keep your extra savings money there. The better money market mutual funds often pay substantially greater interest than bank savings accounts and offer equivalent safety. And if you're in a high tax bracket, money market funds come in tax-free flavors.

· Invest in wealth-building assets. During your working years, while you're earning employment income, you probably don't need or want taxable income from your investments because it can significantly increase your income tax bill. Real estate, stocks, and small-business investments offer the best long-term growth potential, although you need to be able to withstand dips and sags in these markets.

· Fund "tax-reduction" accounts. When you funnel your savings dollars into retirement accounts, such as a 401(k), 403(b), SEP-IRA, Keogh, or IRA, you can earn substantial upfront tax breaks on your contributions. If you think that saving for retirement is boring, consider the tens of thousands of tax dollars these accounts can save you during your working years. If you don't use these accounts to save and invest, you may very well have to work many more years to accumulate the reserves necessary to retire.

· Work overseas. You've always wanted to travel overseas. When you go to work in a foreign country with low income taxes, you may be able to save big-time on income taxes. For tax year 2005, you can exclude $80,000 of foreign-earned income (whether working for a company or on a self-employed basis) from U.S. income taxes. To qualify for this income tax exclusion, you must work at least 330 days (about 11 months) of the year overseas or be a foreign resident. Keep in mind, however, that many of the places you've romanticized about traveling to and perhaps living in--such as England, France, Italy, Sweden, Germany, and Spain--have higher income tax rates than the ones in the United States.

· Trade consumer debt for mortgage debt. Suppose that you own real estate and haven't borrowed as much money as a mortgage lender currently allows. And further suppose that you've run up high-interest consumer debt. You may be able to trade one debt for another. You probably can refinance your mortgage and pull out extra cash to pay off your credit card, auto loan, or other expensive consumer credit lines. You usually can borrow at a lower interest rate for a mortgage, thus lowering your monthly interest bill. Plus, you may get a tax deduction bonus, because consumer debt--auto loans, credit cards, credit lines--isn't tax deductible, but mortgage debt generally is. Therefore, the effective borrowing rate on a mortgage is even lower than the quoted rate suggests. Just remember to factor application fees and other charges into your decision--and don't use the refinancing/home equity line trick as carte blanche to run up more consumer debt in the future.

· Consider charitable contributions and expenses. When you itemize your deductions on Schedule A, you can deduct contributions made to charities. Most people already know that when they write a check for $50 to their favorite church or college, they can deduct it. Yet many taxpayers overlook the fact that they can also deduct expenses on work done for charitable organizations. For example, when you go to a soup kitchen to help prepare and serve meals, you can deduct your transportation costs to get there. You just need to keep track of your bus fares or driving mileage.

· Maximize miscellaneous expenses. A number of so-called miscellaneous expenses are deductible on Schedule A. Most of these relate to your job or career and managing your finances. These expenses are deductible to the extent that, in sum, they exceed 2 percent of your adjusted gross income:

* Educational expenses: You may be able to deduct tuition, books, and travel costs to and from classes if your education is related to your career. But be aware that educational expenses that enable you to change careers or to move into a new field or career aren't deductible.

* Investment and tax-related expenses: Investment and tax advisor fees are deductible, and so are subscription costs for investment-related publications. Accounting fees for preparing your tax return or conducting tax planning during the year are deductible, as are legal fees related to your taxes. If you purchase a home computer to track your investments or prepare your taxes, you may be able to deduct part of that expense, too.

* Job search and career counseling: After you obtain your first job, you may deduct legitimate costs related to finding another job within your field. For example, suppose that you're a chef in a steakhouse in Chicago, and you decide you want to do stir-fry in Los Angeles. You take a crash course in vegetarian cooking and then fly to L.A. a couple of times for interviews. You can deduct the cost of the course and your trips--even if you don't ultimately change jobs. If you hire a career counselor to help you figure everything out, you can deduct that cost, too. On the other hand, if you decide that you want to become a professional volleyball player in L.A., that's a new career.

* Unreimbursed expenses related to your job: If you pay for your own subscriptions to trade journals to keep up-to-date in your field, or if you buy a new desk and chair to ease back pain, you can deduct these costs. If your job requires you to wear special clothes or a uniform, you can write off the cost of purchasing and cleaning them, as long as the clothes aren't suitable for wearing outside of work. If you buy a computer for use outside the office at your own expense, you may be able to deduct the cost of the computer if it's for the convenience of your employer, or if it's a condition of your employment (and is used more than half the time for business). Union dues and membership fees for professional organizations are also deductible.

· Scour for self-employment expenses. If you're self-employed, you already deduct a variety of expenses from your income before calculating the tax that you owe. When you buy a computer or office furniture, you can deduct those expenses (sometimes they need to be gradually deducted or depreciated over time). Salaries for your employees, office supplies, rent or mortgage interest for your office space, and phone expenses are usually deductible. Generally, hiring tax help to figure out what is (and isn't) deductible is worth the money--either by using a book like this one and/or by paying a tax professional to review your return one year.

"It may be too late to take advantage of some of these tips for tax year 2005," reflects Tyson. "But you can keep them in mind for next year or even further down the road. Interestingly, thinking of ways to save tax dollars can lead us to make dramatic lifestyle changes for the better--getting involved in volunteer work, changing careers, or moving overseas, for instance. Of course, you shouldn't drastically alter your life only to save a few tax dollars--but the savings can be a nice fringe benefit!"

About the Authors:

Eric Tyson, MBA, is an accomplished financial counselor and freelance personal finance writer. He is the author of numerous other For Dummies national bestsellers on personal finance, investing, and home buying, and is a syndicated columnist. His work has been critically acclaimed in hundreds of publications and programs, including Newsweek, The Los Angeles Times, The Chicago Tribune, Kiplinger's Personal Finance Magazine, The Wall Street Journal, Bottom Line Personal, as well as NBC's The Today Show, CNBC, PBS's Nightly Business Report, CNN, FOX-TV, CBS national radio, Bloomberg Business Radio, and Business Radio Network. His radio commentaries can be heard on the nationally syndicated public radio Sound Money program. Eric is a former management consultant and holds an M.B.A. from the Stanford Graduate School of Business.

David J. Silverman, EA, has served on the Advisory Group to the Commissioner of Internal Revenue. David has a Certificate in Taxation from New York University and has been in private practice in Manhattan for more than twenty-five years.  He regularly testifies on tax issues before both the Senate Finance Committee and the House of Representatives Committee on Ways and Means. As the result of his suggestions regarding penalty reform that he made while testifying before these committees, legislation was enacted that reduced the amount of penalties that may be assessed in a number of key areas.  David is the author of Battling the IRS, which has received critical acclaim in The New York Times, Money, The Wall Street Journal, and numerous other publications. David has been a contributing editor and wrote a monthly column for Smart Money magazine and is frequently interviewed on national TV and radio as an expert on tax issues.