1. Chapter 4 Lecture 3 Tax Planning and Strategies

2. Individual Income Tax Formula Total Income (everything received) - Exclusions/Tax-exempt Income_______________ = Gross income (GI) - Adjustments______________________________ = Adjusted Gross Income (AGI) - Greater of Standard or Itemized deductions - Personal and dependency Exemptions ($3050 in 2003)__________________________________ = Taxable income (TI) = Taxable income (TI) * Tax rates: 10%-35%______________________ = Tax liability - Tax credits - Tax prepayments___________________________ = Tax due or refund

3. Calculating Adjusted Gross Income (AGI) Adjustments for AGI include: Adjustments for AGI include: Alimony payments. Alimony payments. Moving expenses. Moving expenses. 50% of FICA taxes (social security and Medicare) if self- employed. 50% of FICA taxes (social security and Medicare) if self- employed. 100% of health insurance costs if self-employed. 100% of health insurance costs if self-employed. Payments to a Keogh or SEP retirement plan. Payments to a Keogh or SEP retirement plan. Payments to a Traditional IRA. Payments to a Traditional IRA. Student loan interest. Student loan interest. Tuition and fees. Tuition and fees.

4. IRAs Traditional IRA: Traditional IRA: Contributions are deductible (limited to $4,000 per year). Contributions are deductible (limited to $4,000 per year). Contributions and earnings are taxed when money is withdrawn. Contributions and earnings are taxed when money is withdrawn. Limits if covered by an employer-sponsored plan or if income exceeds a certain amount. Limits if covered by an employer-sponsored plan or if income exceeds a certain amount.

5. IRAs Roth IRA: Roth IRA: Contributions are not deductible. Contributions are not deductible. Can contribute up to $4,000 per year. Can contribute up to $4,000 per year. Individuals whose income exceeds specified limits are not eligible for a Roth IRA. Individuals whose income exceeds specified limits are not eligible for a Roth IRA. Contributions and earnings are not taxed when money is withdrawn. Contributions and earnings are not taxed when money is withdrawn.

6. Student Loan Interest Student loan interest paid is an adjustment to gross income. Student loan interest paid is an adjustment to gross income. Can deduct up to $2,500 per year. Can deduct up to $2,500 per year. There is a phase-out of the amount of the adjustment based on income levels. There is a phase-out of the amount of the adjustment based on income levels.

7. Tuition and Fees Adjustment for qualified tuition and fees paid. Adjustment for qualified tuition and fees paid. Limit is $4,000 per year. Limit is $4,000 per year. Cannot take adjustment in same year claiming a Hope or lifetime learning credit. Cannot take adjustment in same year claiming a Hope or lifetime learning credit.

8. Subtracting Deductions from AGI Take the greater of: Take the greater of: The standard deduction or the total itemized deductions. The standard deduction or the total itemized deductions.

9. Standard Deduction for 2005 Single -- $5,000. Single -- $5,000. Married filling jointly -- $10,000. Married filling jointly -- $10,000. Married filing separately -- $5,000. Married filing separately -- $5,000. Head of household -- $7,300. Head of household -- $7,300. Note: thresholds are indexed for inflation Note: thresholds are indexed for inflation

10. Itemized Deductions Medical and dental expenses paid (must exceed 7.5% of AGI). Medical and dental expenses paid (must exceed 7.5% of AGI). Taxes paid (state income, real estate, and personal property taxes such as vehicle ownership tax). Taxes paid (state income, real estate, and personal property taxes such as vehicle ownership tax). Interest paid (e.g., home mortgage interest). Interest paid (e.g., home mortgage interest). Charitable contributions (cash and noncash). Charitable contributions (cash and noncash). Miscellaneous itemized (must exceed 2% of AGI). Miscellaneous itemized (must exceed 2% of AGI). Tax preparation fees and safe deposit expense. Tax preparation fees and safe deposit expense.

11. Phase-Out of Itemized Deductions Taxpayers in higher income brackets do not get credit for all their itemized deductions. Taxpayers in higher income brackets do not get credit for all their itemized deductions. 2005 married filing jointly – AGI of $145,950. 2005 married filing jointly – AGI of $145,950. Lose deductions equal to 3% of the amount by which your AGI exceeds this amount. Lose deductions equal to 3% of the amount by which your AGI exceeds this amount. Always can take the standard deduction. Always can take the standard deduction. The phase-out of itemized deductions will begin to be eliminated in 2006, disappearing entirely by 2010. The phase-out of itemized deductions will begin to be eliminated in 2006, disappearing entirely by 2010.

12. Classification of Deductible Items Adjustments are “above the line.” Adjustments are “above the line.” See page 1 of Form 1040. See page 1 of Form 1040. Deductions (standard or itemized) are “below the line.” Deductions (standard or itemized) are “below the line.” See page 2 and Schedule A of Form 1040. See page 2 and Schedule A of Form 1040.

13. Claiming Your Exemptions Exemptions are given so that everyone will have a little bit of untaxed money to spend on necessities. Exemptions are given so that everyone will have a little bit of untaxed money to spend on necessities. Is a deduction for each person supported by the income on your tax return. Is a deduction for each person supported by the income on your tax return.

14. Exemptions Two types: Two types: Personal exemption (yourself) – $3,200. Personal exemption (yourself) – $3,200. Dependency exemption - $3,200 each. Dependency exemption - $3,200 each. Must pass a relationship or household member test. Must pass a relationship or household member test. You must provide more than half of the dependent’s support. You must provide more than half of the dependent’s support. Are subject to phase-outs (exemptions can be reduced to $0). Are subject to phase-outs (exemptions can be reduced to $0).

15. Phase-out of Exemptions Once AGI reaches a certain level, the value of the exemptions taken is reduced Once AGI reaches a certain level, the value of the exemptions taken is reduced 2005 – married filing jointly $218,950 (reduction when AGI exceeds this amount). 2005 – married filing jointly $218,950 (reduction when AGI exceeds this amount). For every $2,500 your AGI exceeds this amount, you lose 2% of your exemptions. For every $2,500 your AGI exceeds this amount, you lose 2% of your exemptions.

16. Calculating Your Income Tax Liability Tax Table. Tax Table. Tax Rate Schedules -- must be used if taxable income exceeds $100,000. Tax Rate Schedules -- must be used if taxable income exceeds $100,000. Alternative Minimum Tax (AMT) -- parallel tax system designed to prevent the very wealthy from using the tax breaks to pay little or no tax. Alternative Minimum Tax (AMT) -- parallel tax system designed to prevent the very wealthy from using the tax breaks to pay little or no tax.

17. If taxable income is over-But not over--The tax is: $0$14,60010% of the amount over $0 $14,600$59,400$1,460.00 plus 15% of the amount over 14,600 $59,400$119,950$8,180 plus 25% of the amount over 59,400 $119,950$182,800$23,317.50 plus 28% of the amount over 119,950 $182,800$326,450$40,915.50 plus 33% of the amount over 182,800 $326,450no limit$88,320.00 plus 35% of the amount over 326,450 Schedule Y-1 — Married Filing Jointly or Qualifying Widow(er)