Maloney, Hoffman, Raabe, & Young, CPAs 5191 Natorp Boulevard Mason, OH 45040 04/12/2022 Dan and Freida Butler 625 Oak Street Corbin, KY. 40701 Dear Dan and Freida: Thank you for contacting me again about your tax preparation services. I am pleased that the overall process went smoothly and that you are delighted with the results. I would be happy to address any of your concerns or answer any additional questions you may have. Regarding your question about how your tax liability is calculated, your tax liability is calculated by subtracting your taxable income from all sources from any applicable deductions, which equals your gross tax liability. Your total income tax liability equals your gross tax liability, less eligible tax credits. Options for reducing tax liability are tax credits that lower your actual taxes, lower your tax payments, or increase your tax refund. The more tax credits you claim, the more money you get to keep. Tax deductions, on the other hand, reduce your taxable income. There are several such deductions available to help reduce your taxable income and, as a result, your tax liability. One way to reduce your taxable income for the year is to invest pre-tax dollars in a retirement plan, such as a 401(k). If one is available, you can open a retirement account on your own or through your employer. Individual 401(k) contribution limits are $19,000 in 2019, or $25,000 if you were 50 or older. Another option is to use a health savings account or a flexible spending account, if your employer provides them, to contribute pre-tax dollars toward meeting your health insurance deductibles for the year. For 2020, the maximum allowable contribution amounts are $3,550 for individuals and $7,100 for families. Remember that these funds are yours and are not subject to taxation as long as they are used for specific allowable purposes. It would help if you also thought about converting your existing investments to tax-free municipal bonds. Interest on these is generally exempt from federal income tax and state or locality taxation. However, earnings on these bonds will be lower than on corporate bonds, but this will be offset by a lower tax liability on any gains after the sale. Losses, on the other hand, are fully deductible. In response to your question about qualifying children and dependents for tax credits, they must meet the relationship, residence, age, and support tests to be considered a qualifying child. Individual taxpayers are eligible for the child tax credit and the dependent tax credit based on the number of qualifying children and dependents. • Each qualifying child is eligible for a $2,000 tax credit (including stepchildren and foster children). The child must be under 17, a U.S. citizen, and a taxpayer's dependent to be eligible for the credit. • A $500 tax credit is also available for each taxpayer's dependent (other than a qualifying child). Children over the age of 16 are qualifying relatives for the dependent tax credit (including full-time students under age 24).
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