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A Primer on Federal Income Tax

A Primer on Federal Income Tax

When I was in law school, I took a course in Federal Income Tax.  Aside from that course and my annual tortuous ballet with filing taxes for my wife’s W-2 income, our real estate investment income and revenue from my law practice; I have no particular knowledge or expertise in the subject.

Even though I spent one semester in the course, I’m sorry to say, Prof. Yamamoto; there’s only one lesson I still remember from your class.

“All income is good.  It’s just that some income is better than others.” -Professor Yamamoto, South Texas College of Law

I can’t count the number of times I’ve had an entrepreneur has come into my office and talked about not pulling the trigger of a certain investment or opportunity because he or she didn’t want to deal with the tax hit.

What? As far as I know, there isn’t a single tax owed to the federal government that is 100% (yet?).  That means that you can always keep some portion of the income after paying the taxes due.

 “The best” income.

Tax free income is the best kind of income there is.  It is “free money” and the government doesn’t put its mitts on the money.  So where can we get this “free money.”  Your inheritance from Great Aunt Gertrude is tax-free money.

“Not the best but still better” income.

Tax-deferred income is the next best income.  You do have to pay taxes on the income, but the taxes are not due immediately.  The principle is that by the time you receive the money, you should be in a lower tax bracket and so will ultimately pay less in taxes than you would had you paid them today.  Think of your retirement plan or your employer’s 401(k) plan.

“Still good” income.

Finally, there’s regular taxable income.  There are, however, several varieties of taxable income.  There is ordinary income which is like your salary or revenue from your business.  There is short and long-term capital gains income.  In many cases, the tax rate of your capital gains can be lower than your ordinary income tax rate.

Make sure you have a knowledgeable tax professional on your team to help you minimize your tax liability.  A good CPA will help you properly put your income in the right “Still Good,” “Note the Best But Still Better,” or “The Best” income bucket.

If you need an introduction to a good CPA, please contact me and I’d be happy to make an introduction.

 

[Photo credit: Got Credit]

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