Tax Planning for Low-Income Taxpayers

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Table of Contents

Tax Benefits Provided by Government
Tax Planning
Tax Planning Issues for Small Business and Entrepreneurs with Low Income
Influence by Tax Planning Transformations 2008
Conclusion
References

Tax Benefits Provided by Government

It is stated that the current Government is going to reverse the family trust changes introduced by the previous Government. The definition of family in the family trust selection regulations will be changed to restrict lineal successors to children or grandchildren of the test persons or the test someone’s spouse. This modification of the taxation system was represented in July 2008. Consequently, as Karl (2003) emphasizes “if a family trust was regarded as the trust which is aimed at making distributions to family that will be excluded from the test personal family group make sure it is before 1 July 2008. Family trusts will be prevented from performing a once off variation to the test personal specified in a family trust election (other than in relation to a marriage breakdown). Nevertheless this change will be retrospective from the viewpoint of the taxation rules of the 2007/08 income period”.

The government offers a tax program for families with children up to 13, and this program offers compensation of 35% of child care costs and up to $3,000 per child or dependent. As this tax credit is non-refundable, the families receive only the sum, which they have paid in taxes.

Fuller and Sharon (2002) state that New York State offers a refundable tax credit of up to 110 percent of the amount for which the families were eligible from the federal tax credit (whether or not they received it from the federal government). In contrast to the federal tax credit, the New York State child care tax credit is refundable so a very low income individual who does not have an income tax liability can still receive money.

The fact is that the opportunity for making all these variations off may be restricted, if not lost. These changes decrease the scope for family trusts for utilizing the possible tax losses and franking credits in order to decrease the income tax rate. The other changes of the Family Trust regulations were represented by the previous Government will not be invalidated entailing; permitting different variations in the family group that may happen as a result of death, divorce or birth and permitting family trust elections to be annulled in circumstances where the initial elections were not actually needed. Nevertheless, it is claimed by Fuller and Sharon (2002) that as a result of the tax-free threshold and low income offset taxpayers (other than minors) with income below $11,000 do not pay tax, consider ways of assigning income to any low income personalities in the family group. It is also necessary to emphasize that the threshold will increase to $14,000 for the 2008/09 tax year.

It is necessary to mention that when the employee leaves the service of the employer, one has an absolutely crucial decision to take. It is claimed that “such worker is oblige to estimate and select whether he / she is better off leaving the retirement financial reserves in the current qualified 401k retirement pension plan (if it is allowed by the plan itself), changing the company’s qualified plan such as a 401k plan, or rolling over to an IRA, by way of an IRA rollover.” (Brown, Williams 2007). Originally, if this process is managed properly, the 401k rollover according to IRA, makes it possible to maintain tax-deferred status by qualified retirement funds. Consequently, the employee has an opportunity to avoid tax withholding (20%) and penalty for premature retirement.

The instances of IRA and 401k are given in Brown and Williams (2007). They emphasize the following fact: “with a rollover IRA the investment options are open to most all investments (tremendous rollover IRA advantage). Within a qualified retirement pension plan employee’s choices are usually restricted to the selections (maybe two or three dozen) made available within the company-sponsored 401k plan. IRA rollovers currently allow for the most flexibility regarding distribution options and beneficiary selection.” This, originally, can be highly valuable in regards to extending IRA multi-generational planning. The A 401(k) plan can provide numerous advantages for the low-income taxpayers. Originally, these advantages entail the possibility to decrease the tax rate, and also lowering if the taxable income, and making savings that accumulate without making deposits. Thus, in 1978 Congress decided to encourage the American population to save finances for their retirement. Originally, this was aimed to lower the federal taxes and enhance some additional income by decreasing taxes. The tax reform act, which originated from this decision, supported the elaboration of the tax-deferred savings program for workers. However, the first 401(k) program was launched in 1982. It was a “defined contribution” program that allowed any employer or employee to set up the sum of money, which should be directed to the fund.

As for the single mothers, it is necessary to emphasize that the Government has also elaborated the program, allowing them to reduce their taxes and gain untaxable allowances for raising children.

Chesser and Harrison (2003) in Journal of Accountancy claim the following: “For the single mother to be eligible, one has to have earned income during the year, but beneath a particular level. This credit can add thousands to your tax refund and is a form of government-sponsored support for working single mothers. You can choose to have it show up directly in your paycheck the following year, instead of waiting for the end of year to file and receive the benefit”.

Taking into account the possibility to apply ROTH strategy instead of IRA, it should be stated that the biggest disparity between these two approaches is the way, the taxes are treated. (Traditional vs. Roth IRA: An Introduction and Comparison, 2009) If the yearly profits are $70000 and higher and $4000 are put in traditional IRA, the taxes will be paid from the rest $66000. Nevertheless, if these $4000 are put in traditional ROTH, these in no way will be regarded as the income tax deduction. Fuller (2002) in his turn states the following: “The Roth IRA is going to make more sense in most situations. A person filing the taxes as single can not make over $95,000. Married couples are better off, with a maximum income of $150,000 yearly.”

Tax Planning

As for the matters of tax planning which are aimed to simplify the tax system in general and not to bother people with the complexities of the bureaucratic system, it should be stated that the effective system is based on salary sacrifice. For clear understanding of the mechanism, it is necessary to cite Edward (2003) in his “Tax-Planning Services…” : “An effective salary sacrifice system is based on the arrangement between the taxpayer and the employer detailing the exact salary rate or income which will be sacrificed. It is advised that the worker and the employer agree upon all the conditions of the wages forfeit arrangement. This arrangement should enter into force before the assignment is performed. Finally, the employer should not have any access to the salary being sacrificed for the period of the arrangement.”

Originally, the changes in the tax planning system touched deemed dividends allowing taxpayers not to apply to the Commissioner in case of their obtaining. It is said, that the permission for not applying to Commissioner was introduced to taxpayers to declare the dividends and get the tax credit for the future (Fuller and Kagan, 2002)

Tax Planning Issues for Small Business and Entrepreneurs with Low Income

The companies are obliged to take into tax accounting the profits and losses which originate from their financial contacts, that reflect the generally accepted accounting practice (GAAP). There are two accounting tools regarded as authorized: mark to market (it is generally resorted to by financial traders) and accruals.

Business turnover lower $2 million means special tax benefits such as a simplified trade regime and tax offset. In case of advance income it should be compulsorily credited; there should be certain contributions to the political parties’ development for about $1,500. Investments in education and social funding should be compulsory observed. As Crouter and Booth (2004) found in their research: “The earned income credit is a refundable credit for certain qualified workers. It is aimed at helping offset some of the increases in living expenses and social security taxes. This credit reduces the amount of tax owed, if any, and may result in a refund to the taxpayer.” From this point of view, the suitable workers may perceive some part of their income credit in their paychecks. For being suitable, the employee must have a child (under 18), and expect to fall into certain income restrictions, and meet other specific requirements. Which are generally stated in W-4 form, Earned Income Credit Advance Payment Certificate, and in more detail in Publication 596, Earned Income Credit, as stated by Crouter and Booth (2004)

From this point of view, the applying of examples will help in the issues of clarifying these strategies. Thus Perez (2009) states that by filling out any new form for the employer, any worker is free to make all the required adjustments for the withholding. As for the W-4 modifying, it is often emphasized that there is an opportunity to decrease the amount of the declared allowances according to line 5 of the W-4, or it may be done according to line 6: the wished amount for being withheld may be added. Garwood (2008) in his turn states the following: “The more you have withheld, the more likely your tax bill will be covered and you will not owe money at tax time. In fact, you may benefit from a refund check. For those who are not very good at setting money aside for taxes, having more taken out of your weekly or biweekly paycheck is a benefit.”

As for the rules of qualifying children for the aims of claiming the earned income credit, it should be stated that they are different from the rules for dependents. From this point of view it should be stated that it may be possible that a child may be qualified as the taxpayer’s dependent, but not for EIC; or would qualify for EIC. Here are the qualifying children rules for the earned income credit:

Relationship test
Age test
Residency test.

To claim a qualifying child or children it is necessary to attach Schedule EIC to Form 1040. (Perez, 2009)

Influence by Tax Planning Transformations 2008

It has been already emphasized that the threshold will increase to $14,000 for the 2008/09 tax year. Taking this into account it is necessary to state that such a threshold is aimed at increasing the possibility of giving tax credits, allowances and tax planning system capabilities. It is claimed that if such contributions are paid for the advantage of an associate, these contributions are regarded as fringe benefits. Consequently, where these contributions are paid to a non-accomplishing superannuation fund they will be regarded to be a fringe advantage.

Taking into account the tax-paying system for the low-income taxpayers, there are several filling status issues. Fuller and Kagan (2002) give 5 categories:

Single. This is applied to everyone who is unmarried, divorced or separated by the state law.
Married, applying jointly. A married couple may post a joint return. If a spouse died during the year, the other has an opportunity to file a joint return with that spouse for the year of death.
Married applying separately. A married couple may elect to file their returns separately.
Widow(er) with Dependent Child. A taxpayer is granted with an opportunity to choose this filing status if the spouse died during 2006 or 2007, a taxpayer has a dependent child and he o she meets certain other conditions.

This is regarded to be a strategy for married couples. If one of the spouses has a steady income and the other is a freelancer, the setting up of the withholding may be very helpful. Karl (2003) emphasizes that claiming for more withholding for any person with a steady salary will be really beneficial if the spouse who is an independent contractor has essentially higher earnings. This can be adjusted, should the independent working spouse have lower earnings, and can help ensure that they are covered at tax time.

Originally, if there is a strong necessity from the side of a taxpayer to make sure there is enough withheld to cover the tax obligations, any taxpayer does not want to have too much money withheld. This money may be invested and the attained profits may be derived from the interests.

Thus, based on these categories, the individuals having salary-packaged benefits and $180 000 or less taxable income are to review their sacrifice arrangements. Individuals with income lower than $11000 are not to pay tax – it is connected with low-income offset and tax-free threshold. The tax rate for minors (under 18 years children) make about 45%, the tax-free threshold is about $1,667, being increased to $2,667.

Another instance of married couple strategy tax-reducing may be applied in the case of one of the spouse’s death. Originally, it is stated that the NRB (nil-rate band) would result in a substantial IHT (inheritance tax) saving. However, this strategy has essentially changed since the transferable nil-rate band (TNRB) was represented on 9 October 2007 in the Pre-Budget Report. The instance of this strategy application is stated in Garwood (2008): “For example, say John died in 1995 having used only 75% of his NRB. If his wife Mary dies in 2009, her NRB will be [pounds 325,000 (2009/10 NRB). This will be increased by the 25% unused proportion of John’s NRB so she has an NRB of [pounds] 406,250, thereby reducing the IHT on her estate by a further [pounds] 32,500.”

Conclusion

In conclusion, it is necessary to mention that the opportunities provided by tax planning formation made some benefits to individuals with low income; though there are certain contradictions between state and federal policies striving to help such people.

Originally, the taxpaying structure for low-income taxpayers is essentially simplified, and, it is necessary to mention that they are granted lots of additional opportunities, which allow them to decrease the tax rate, decrease the threshold of the income tax and receive the tax credit, which is based on the social position, personal circumstances or working conditions which potentially may lead to the decreased income rates.

The strategies and systems which are widely represented in the paper offer different ways for declaring incomes, and depending on the way of this declaration, tax rates and allover sums vary. Originally, it is linked with the notion that citizens should have an opportunity to gain help from Government, on the other hand, this help is possible only if the taxes are thoroughly paid by all the citizens.

References

Brown, Carol Necole, and Serena M. Williams. “The Houses That Eminent Domain and Housing Tax Credits Built: Imagining a Better New Orleans.” Fordham Urban Law Journal 34.2 (2007): 689
Chesser, Delton L., Walter T. Harrison, and William R. Reichenstein. “Investment Tax Planning for Retirement: How to Make Taxes Work for the Client.” Journal of Accountancy 196.2 (2003): 63
Crouter, Ann C., and Alan Booth, eds. Work-Family Challenges for Low-Income Parents and Their Children. Mahwah, NJ: Lawrence Erlbaum Associates, 2004.
Fuller, Bruce, Sharon L. Kagan, Gretchen L. Caspary, and Christiane A. Gauthier. “Welfare Reform and Child Care Options for Low-Income Families.” The Future of Children 12.1 (2002): 97
Garwood, Paul. “Financial And Tax Planning, Summer 2008 – Maximising Your Returns.” Mondaq Business Briefing, 2008
Karl, Edward. “Tax-Planning Services for Clients or Employers: CPAs Should Understand Their Responsibilities.” Journal of Accountancy 196.6 (2003): 69
Perez, William. “2009 Tax Rate Schedules. Tax Brackets for the 2009 Tax Year” Tax Planning: U.S. 2009
“Traditional vs. Roth IRA: An Introduction and Comparison”. Flexo, 2009.

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