Income tax lawyers specialize in preparing income tax returns for individuals and businesses. Tax lawyers can also advise clients on complex tax issues. Tax lawyers handle disputes with the Internal Revenue Service (IRS) and state taxing agencies.
Disputes can often be resolved by filing an amended tax return. If a dispute over taxes is significant, the case could end up in court and a tax lawyer can represent the taxpayer in court.
How Is Income Tax Calculated?
To calculate their income tax, a person must first calculate their Gross Income (GI). Then deductions can be subtracted from gross income to arrive at Adjusted Gross Income (AGI). The applicable tax rate is applied to AGI, and the result is the amount of income tax the person owes.
What Is Gross Income?
Section 61 of the Internal Revenue Code defines gross income as “all income, from whatever source derived.” In other words, gross income is any income received during the tax year, including wages or a salary from a job, profits from the sale of stocks, income from rentals, and even income from activities that are illegal. The person who gives financial gifts may owe tax on the amount given; there are qualifications and limitations on this. For most taxpayers, the tax year is the calendar year, so income received between January 1 and December 31 of a calendar year is gross income for that year.
Not all income is taxed; some types of income are exempt. However, determining gross income is the first step in calculating taxable income. All income, from whatever source, must be included in gross income with some exceptions.
Some kinds of income are exempt from taxation. Remember that there may be qualifications and limitations to these exemptions. Some examples are as follows:
- Disability Insurance Payments: Payment received from disability insurance that a person paid for themselves are not taxable; payments from a state’s workers’ compensation insurance system are not taxable;
- Accident or Health Insurance: The value of accident or health insurance provided by an employer is not treated as income;
- Life Insurance: Payments made pursuant to a life insurance policy are not considered income;
- Income Earned by Residents of 7 States: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming do not have an income tax. New Hampshire and Tennessee only tax only income from interest on accounts and dividends, not income as salaries and wages; some states do not tax Social Security income or income from a pension.
- Capital Gain on Sale of a Principal Residence: If a person makes a profit on the sale of their permanent residence, the gain is not treated as taxable income; their are qualifications and limits on this exemption;
- Money or Property Received as an Inheritance: A large estate may have to pay inheritance taxes, but the recipients of inherited property do not have to pay taxes on their inheritance.
- Income from Foreign Sources: Some types of income from foreign sources do not count as taxable income in the U.S.; for example, social security from a foreign government might be exempt from taxation.
What Is Adjusted Gross Income?
Adjusted gross income (AGI) is a taxpayer’s gross income minus certain deductions that are allowed by the Internal Revenue Code. Deductions are amounts of money that can be subtracted from gross income in order to calculate AGI. So, a person does not pay taxes on income that is deducted from gross income. Do not confuse a deduction with a tax credit. A credit is an amount that can be deducted from the amount of tax that a person owes after that amount has been calculated.
Following are the most important deductions for most average American wage-earners. Each type of deduction is subject to its own set of restrictions, rule and qualifications:
- Mortgage Interest: The interest paid on their home mortgage: The interest on a mortgage with a value of up to $750,000 is deductible;
- Charitable Contributions: with a limit of $60,000, charitable deductions are deductible;
- Medical Expenses: medical expenses are deductible only in an amount that is more than 10% of the taxpayer’s AGI; in other words, medical expenses only become deductible when the value is over 10% of a taxpayer’s AGI; if a taxpayer has AGI of $100,000, then medical expenses over $10,000 are deductible;
- Property Taxes: property taxes paid on real property, an auto or other personal property;
- State and Local Income Taxes OR Sales Taxes: there is a limit of $10,000 per taxpayer for the property tax and local income or sales tax deduction. In other words, the total deduction for these items combined cannot be more than $10,000.
There are some other deductions that are important for many taxpayers and they are available whether the taxpayer itemizes deductions or not. They are as follows:
- Contributions to an IRA: contributions to an Individual Retirement Account (IRA) of up to $6,000 (or $7,000 if a person is over 50) are deductible; of course, after a person retires and takes the money out of the IRA, it becomes taxable income; there are many rules and regulations regarding IRAs;
- HSA and FSA Contributions: contributions to a Health Savings Account (HSA) or a Flexible Savings Account (FSA) to cover eligible healthcare expenses; contributions to an HSA can remain in the account from year to year, whereas only $500 in FSA contributions can be carried from year to year; there are limits to the amount that can be contributed in one year.
- Student Loan Interest: up to $2500 in student loan interest can be deducted per year.
Significant additional deductions are available to individuals who are self-employed, i.e. they receive notification of their income on a Form 1099. They are as follows:
- Qualified Business Income: The QBI deduction allows most self-employed taxpayers to deduct 20% of their income;
- The Home Office Deduction: The home office deduction applies if you use part of your home exclusively for business, and remember, a person must be self-employed; if a person is working at home and receive a paycheck from an employer, the home office deduction does not apply;
- Half of the Self-employment Tax: Half of the self-employment tax, i.e. the withholdings that a person must pay for Social Security and Medicare, is deductible as a business expense.
- Retirement Account Contributions: several different kinds of retirement savings accounts are available to the self-employed, and contributions to these accounts are deductible; there are contribution limits but they are relatively high.
- Other Costs of Doing Business: Such items as travel expenses, the cost of office supplies, advertising expenses, and the cost of mileage driven for business purposes are all deductible for the self-employed.
What Is Taxable Income?
Taxable income is the amount of income for which taxes must be paid. Every taxpayer needs to decide whether to take the standard deduction or itemize deductions. The standard deduction is an amount of money that the government specifies that every adult can subtract from their gross income. The vast majority of taxpayers take the standard deduction because that results in the lowest AGI.
Itemizing deductions involves listing a set of deductions to which a person is entitled and subtracting each from gross income. This results in a lower AGi for some taxpayers. It is an option that each taxpayer has. Taxpayers calculate their taxable income by subtracting either the standardized deduction or itemized deductions from their AGI.
Once the taxpayer has calculated their taxable income, the taxpayer can then calculate their tax. Income tax is calculated by applying the taxpayer’s current tax rate to their taxable income. Tax rates vary depending on the taxpayer’s adjusted gross income, marital status, and the number of dependents they may have.
Of course, if a taxpayer has had federal or state taxes withheld from income payments, then in a final step the amount of tax owed will be compared to withholdings. If the taxes owed are less than the withholdings, then the taxpayer will get a refund. If the amount of withholdings is less than the taxes owed, the taxpayer will have to pay the difference to the IRS or state taxing agency.
Should I Contact an Income Tax Lawyer?
Tax issues can be complex and may require professional assistance. Tax fraud can result in serious consequences, such as substantial fines or even prison time. If you have failed to pay taxes for several years, have substantial back taxes, or are being audited, you should most definitely contact an experienced tax lawyer for help.
Or if the IRS notifies you that you have underpaid your tax obligation or misapplied a deduction, if the amount the IRS seeks to recover is significant, you may want to consult an experienced tax lawyer. A tax lawyer can calculate your taxes and figure out how much return you rightly owe the IRS. Tax lawyers can communicate with the IRS and resolve problems by amens. Or, if you must go to court, your tax lawyer can represent you in litigation. It is always a good idea to have an experienced tax lawyer fighting for you in disputes with the IRS.