Reducing Your Tax Rate

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

• 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 to shift investment assets to your children. If you have a small business, you can hire your children. Another possibility is to make one or more children part-owners of your small 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.
• Structuring an investment or 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.
• Choosing the optimal form of organization for your business (such as sole proprietorship, partnership, or corporation). If your business income is under $75,000 and your business is not a personal service business like medicine, law, architecture, engineering, accounting, the arts, or consulting, you may be able to save tax dollars by incorporating. Otherwise, the sole proprietorship or pass-through entities (partnerships, LLCs, S corporations) usually offer more tax benefits.

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.

As a result of tax law changes in 2001, there are now six tax brackets for individuals: 10 percent, 15 percent, 27.5 percent, 30.5 percent, 35.5 percent, and 39.1 percent. The dollar amounts at which each bracket begins is different for each filing status (that is, whether you file as single, head of household, married filing jointly, or married filing separately) and are adjusted for inflation each year.

The following chart shows the income thresholds at which each tax bracket begins for 2001. For 2001, taxpayers receive the benefit of the new 10 percent tax rate through a refund check or a rate reduction credit. Note also 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.

The following tax brackets are projected for 2002: