How to Calculate Maximum Tax Shields
Original post by Dennis Hartman of Demand Media
Tax shields are optional techniques and provisions in tax codes that allow taxpayers to reduce the amount they owe. As an investor, you likely can take advantage of more than one tax shield through strategic investment management, and by claiming credits and deductions. Some tax shields conflict with one another, preventing you from claiming them all. Before tax season you can evaluate your tax situation, and calculate your maximum tax shield to save as much money as possible.
Select a tax return to file. For most individuals, federal Form 1040 is adequate for reporting investment income. For businesses, there are several options depending on the type of business you run. Choose a state tax return if you live in a state with individual income tax. Use the same type of return as the previous year if your financial situation is similar.
Prepare your federal tax return on paper or by filling out a template online. Use your financial records from the year to claim itemized deductions for your investment expenses, including broker fees, investment software and research costs. Claim a capital loss on Schedule D if you sold investments for a loss during the year.
Read the tax return instructions in full to ensure that you claim each tax shield element available to you. Note any deductions that you fail to qualify for because of deductions or credits you claimed earlier.
Record the amount of tax you owe, or the refund you will receive, at the end of your tax return. Note the deductions and credits you claimed to arrive at this number.
Prepare your federal tax return a second time. Claim a different combination of deductions and credits using information from the same financial records. Record your tax or refund due, along with which tax shields you used to calculate it.
Prepare your federal return a third time. Claim the standard deduction instead of itemizing your deductions for investment expenses. Record the results.
Compare your record of tax results from the three passes over your federal tax return. Subtract the lowest tax due from the highest to determine the difference. This is your maximum tax shield. The form with the lowest tax due represents the combination of deductions and credits that will produce the greatest tax shield savings.
Use the data from your federal income tax return with the lowest tax liability (the form that you plan to file) to complete a state return, if necessary. Complete your state tax return only once.
Tips & Warnings
- Tax shields change from year to year, so stay up to date on the rules to determine what your maximum tax shield is for the current year.
- If your investment income comes from many different sources, or if you run a large business, consider hiring a tax professional to calculate tax shields for you.
- State and federal tax returns
- Financial records
- Internal Revenue Service: Publication 550 (2010), Investment Income and Expenses
- Charles Schwab: Investment Expenses: What's Tax Deductible?
About the Author
Dennis Hartman is a freelance writer living in California. His work covers a wide variety of topics and has been published nationally in print as well as online. Hartman holds a Bachelor of Fine Arts from Syracuse University and a Master of Arts from the State University of New York at Buffalo.
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