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Reducing Your Tax Rate

April 13, 2006

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Although you can't literally lower your tax rate, there are certain actions you can take that will have a similar result. These include:

• Choosing the optimal form of organization for your business (such as sole proprietorship, partnership, or corporation).
• Structuring a transaction so that payments that you receive are classified as capital gains. Long-term capital gains earned by noncorporate taxpayers are subject to lower tax rates than other income.
• Shifting income from a high-tax-bracket taxpayer (such as yourself) to a lower-bracket taxpayer (such as your child). One fairly simple way to do this is by hiring your children. Another possibility is to make one or more children part-owners of your business, so that net profits of the business are shared among a larger group. The tax laws limit the usefulness of this strategy for shifting unearned income to children under age 14, but some tax-saving opportunities still exist.

When we say "tax bracket," we're referring to the highest federal tax rate that you pay on any of your taxable income. This is the rate that will apply to each additional dollar that you earn, until you earn so much that you graduate to the next bracket. You need to know your current tax bracket in order to make wise tax planning decisions, since many decisions will make sense for those in certain brackets, but not for those in others.

In 2001, the tax laws were changed to lower the tax rates across the board and create a new 10 percent income rate. Beginning in 2003, the Jobs and Growth Tax Relief Reconciliation Act of 2003 accelerates further tax rate reductions that were otherwise to take effect in 2006.

The dollar amounts at which each bracket begins are different for each filing status (that is, whether you file as single, head of household, married filing jointly, or married filing separately). The new tax rates for each year are as follows:

The following chart shows the income thresholds at which each tax bracket begins for 2006. Note that the dollar amount does not refer to your gross income, but rather, your taxable income--that is, income after you've subtracted any deductions and personal exemptions to which you're entitled.

Among the Business Tools are Form 1040 and IRS Tax Tables. They are in Adobe Portable Document Format (.pdf), and you will need the free Acrobat Reader to view and print the file.

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