Figure next year's taxes today

Your Money

January 28, 2007|By Humberto Cruz | Humberto Cruz,Tribune Media Services

As W-2s, 1099s and other tax forms arrive, many Americans are beginning the dreaded chore of computing their federal income taxes for 2006.

My wife, Georgina, and I are just about done - for 2007. For 2006, we were basically done a year ago (with the computations, that is).

Every January, we estimate our tax liability for the coming year. It takes us less than an hour, despite a fairly complicated tax situation as self-employed sole proprietors. For most Americans, the same exercise should take a half-hour.

The benefits are many. You'll know early on how much of the money you make you get to keep, so you can set up realistic spending and savings goals. You will also avoid having too much money withheld for taxes.

Just doing the exercise will give you an understanding of basics that makes it easier to implement simple tax-saving strategies.

First, some essential disclaimers. Tax laws can be highly complicated, and nobody can cover everything in a short space. If your tax situation is complex or you may be subject to the alternative minimum tax, you would do well to do additional research and/or consult a tax professional. The example I give is extremely simplified, ignoring the impact of potentially significant tax breaks, such as the child credit and other credits, and contributions to tax-deferred retirement plans.

Still, for many people with average incomes and straightforward returns, this could be a guide:

The first thing to understand is that not all income is taxed. (Some forms of income, such as interest from municipal bonds, are exempt from income taxes, for example.) But even income that would normally be taxed, such as your salary, is tax-free up to a certain amount.

For example, taxpayers not claimed as dependents on somebody else's return are entitled to a personal exemption of $3,400 for 2007, up from $3,300 in 2006.

That means the first $3,400 of income in 2007, even when normally taxable, is tax-free. You get an exemption from each dependent, including yourself. A married couple with no children and filing a joint return can claim $6,800 in exemptions for 2007.

On top of exemptions, we can claim deductions. You can itemize deductions for money spent on items that qualify, such as mortgage interest, medical expenses and charitable donations. Or, as many taxpayers do, you can simply claim a "standard deduction," even if you don't spend a cent on deductible expenses.

For 2007, the standard deduction for a married couple filing jointly will be $10,700. The couple in our example would not owe any income taxes on at least the first $17,500 of income ($6,800 plus $10,700). If this couple had itemized deductions above $10,700, they could claim the higher amount instead of the standard deduction.

Key point: Only income that exceeds the combined exemption and deduction amount is taxable. For joint filers, the first $15,650 of taxable income in 2007 will be taxed at 10 percent; income between $15,650 and $63,700 at 15 percent, with higher incomes taxed at progressively higher rates up to 35 percent. (For all the rates and brackets for each filing status, do a search for "2007 tax rates" on the Internal Revenue Service Web site, www.irs.gov.)

For our married couple, if their only income was $60,000 in salary, taxable income would be no more than $42,500. Of that, $15,650 would be taxed at 10 percent ($1,565 in taxes) and $26,850 would be taxed at 15 percent ($4,027.50 in taxes). The total income tax bill would be $5,592.50.

yourmoney@tribune.com

Humberto Cruz writes for Tribune Media Services.

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