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Cook and Company, Enrolled Agents


 
 

 

Common Taxpayer Mistakes

 

The taxpayer has taxable interest income and nondeductible  consumer debt interest where the "spread" is negative.  A negative spread exists where the after-tax cost of the borrowed funds exceeds the after-tax income from the investment.

Example:  A person has an auto loan with an interest rate of 8.5%.  The federal tax bracket is 28% and state is 5%.  Because the interest is non-deductible, the true cost is closer to 11%.  This same person has a CD that is earning 6%.  The interest income from the CD is taxable and the after-tax yield is closer to 4%.

  Solution; A better use of the taxable income producing investment would be to pay off the consumer debt.

The taxpayer is carrying a large amount of consumer debt  with the ability to obtain an equity loan on his/her home.  

Solution; Replace the consumer debt with a home equity loan.  

Reasoning;  The taxpayer in the example above must earn approximately $ 1.31 to $1.37 in order to pay $ 1.00 of non-deductible interest.  If the taxpayer can make the interest deductible by transferring the debt to a home equity loan, he will need to earn only $ .63 to $ .69 to pay $ 1.00 of interest!   

Homeowners sometimes make extra payments to pay off their  mortgage more quickly even as they continue to carry the more costly credit card debt.

Funding  a tax deductible IRA while ignoring an employers  401{k} plan  which  offers  not  only  a tax  deduction  but  also a matching company contribution.  

 Non-cash charitable contribution.  Most taxpayers could donate enough old clothing, furniture, etc., to claim the $ 500 deduction limit IRS allows without filing form 8283. 

Failure  to  participate, or  maximize participation  in retirement plans such as  401 [k], 403[b], IRA, Roth IRA, SEP, and Keogh Plans.  Many taxpayers do not realize how little this costs and how much of the plan is in essence being subsidized  by government.  There is a misunderstanding regarding  the 10%  early  withdrawal  penalty.  The investment income earned on the tax deferred savings will generally equal the 10% penalty  after 5-7 years.  

Taxable Social Security. By utilizing growth stocks and tax-deferred investments, such as annuities and government bonds, taxable Social  Security can often be reduced and possibly avoided.   If investment income causes more of the Social  Security to be taxed, the yield is not only reduced by the tax on the investment income, but also by the additional tax paid on the Social Security Benefits.

Not investing in equity securities. 

Neglecting  to write a will.

 
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Copyright © 1994-2010 Cook & Co. Toll-Free Nationwide 1-800-551-6253 or 6254  Main Tel. 256-586-4111 Fax 256-586-4138 Bara Business Center 124 South Main Street  Arab, Alabama 35016  Direct Phone Lines From Birmingham: 322-7452 Huntsville: 534-6922  Cook & Co., Enrolled Agents are licensed by the U.S. Treasury Department to represent taxpayers before the Internal Revenue Service (IRS). Greg Cook is a Certified Public Accountant (CPA) licensed by the states of Alabama and Tennessee.

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