Personal Finance Garman/Forgue Ninth Edition Chapter 4: Managing Income Taxes PPT slide program prepared by Amy Forgue and Ray Forgue.

Learning Objectives Explain the nature of progressive income taxes and the marginal tax rate. Differentiate among the eight steps involved in calculating your federal income taxes. Use appropriate strategies to avoid overpayment of income taxes. Copyright ©Houghton Mifflin Company. All rights reserved.

Introduction Tax Planning: Seeking legal ways to reduce, eliminate, or defer income taxes. Taxable Income: the income upon which income taxes are levied. Copyright ©Houghton Mifflin Company. All rights reserved.

Taxes Progressive income taxes and the marginal tax rate Internal Revenue Service (or IRS) Internal Revenue Code The progressive nature of the federal income tax Progressive tax Regressive tax Copyright ©Houghton Mifflin Company. All rights reserved.

The Marginal Tax Rate Marginal tax bracket (or MTB) Marginal tax rate Indexing Copyright ©Houghton Mifflin Company. All rights reserved.

Marginal Tax Rate and Financial Decisions Your effective marginal tax rate is probably 43%. Your average tax rate is lower. Average tax rate: Proportion of total income paid in income taxes. Copyright ©Houghton Mifflin Company. All rights reserved.

8 Steps in Calculating Your Income Taxes Determine your total income. Determine and report gross income after subtracting exclusions. Subtract adjustments to income. Subtract either the IRS’s Standard Deduction for your tax status or itemize your deductions. Copyright ©Houghton Mifflin Company. All rights reserved.

8 Steps in Calculating Your Income Taxes Subtract the value of your personal exemptions. Determine your preliminary tax liability. Subtract tax credits for which you qualify. 8. Calculate the balance due the IRS or the amount of your refund. Copyright ©Houghton Mifflin Company. All rights reserved.

Total Income Total Income: Compensation from all sources. Copyright ©Houghton Mifflin Company. All rights reserved.

Total Income Income to include: Wages and Salaries Commissions Tips Earned Gambling and Lottery Winnings Include capital gains and losses in Total Income. Long-term gain (or loss) Copyright ©Houghton Mifflin Company. All rights reserved.

Gross Income Determine and report your gross income after subtracting exclusions. Copyright ©Houghton Mifflin Company. All rights reserved.

Gross Income Income to exclude: Gifts Inherited money or property Income from a carpool Federal income tax refunds Copyright ©Houghton Mifflin Company. All rights reserved.

Gross Income More income to exclude: Employee contributions to flexible spending accounts Reimbursements from flexible spending accounts Child support payments received Copyright ©Houghton Mifflin Company. All rights reserved.

Subtract Adjustments to Income Adjusted Gross Income (or AGI) Copyright ©Houghton Mifflin Company. All rights reserved.

Deductions Subtract either the IRS’s standard deduction for your tax status or your itemized deductions. Standard deduction depends on filing status. $5350 for single individuals $10,700 for married couples Copyright ©Houghton Mifflin Company. All rights reserved.

Deductions Itemized deductions: Medical and dental expenses Copyright ©Houghton Mifflin Company. All rights reserved.

Deductions Itemized deductions: Taxes you paid Real Estate Property Taxes (home or land) Personal Property Taxes State, Local, and Foreign Income Taxes State and Local Sales Taxes (instead of state and local income taxes) Copyright ©Houghton Mifflin Company. All rights reserved.

Deductions Itemized deductions: Taxes you paid Interest Paid on Home Mortgage Loans “Points” Interest Paid on Home-Equity Loans Copyright ©Houghton Mifflin Company. All rights reserved.

Deductions Itemized deductions: Interest you paid Interest paid on loans used for investments Mortgage insurance premiums on new loans after January 1, 2007 Copyright ©Houghton Mifflin Company. All rights reserved.

Deductions More itemized deductions: Gifts to charity Casualty and theft losses Copyright ©Houghton Mifflin Company. All rights reserved.

Deductions Miscellaneous deductions in excess of 2% of adjusted gross income Other miscellaneous deductions allowed at 100%: Gambling losses Business expenses for workers with disabilities Copyright ©Houghton Mifflin Company. All rights reserved.

Exemptions Exemption (or Personal Exemption) Subtract the value of your personal exemptions. Each exemption reduces taxable income by $3400. Copyright ©Houghton Mifflin Company. All rights reserved.

Exemptions Claiming another person as an exemption What if you are claimed as an exemption? If someone else claims you, you cannot claim yourself. The opposite is also true. Copyright ©Houghton Mifflin Company. All rights reserved.

Tax Liability Determine your preliminary tax liability. Subtract tax credits for which you qualify. Tax Credit: Dollar-for-dollar decrease in tax liability. Copyright ©Houghton Mifflin Company. All rights reserved.

Tax Credits Hope Scholarship Credit Lifetime Learning Credit Earned Income Credit Child Tax Credit Child and Dependent Care Credit Retirement Savings Contribution Credit Copyright ©Houghton Mifflin Company. All rights reserved.

Tax Liability Calculate the balance due the IRS or the amount of your refund. Copyright ©Houghton Mifflin Company. All rights reserved.

Avoid Taxes Through Proper Planning Practice legal tax avoidance, not tax evasion. Copyright ©Houghton Mifflin Company. All rights reserved.

Avoid Taxes Through Proper Planning A dollar saved from taxes is really two dollars - or more. Opportunity cost Earning another dollar to replace one given to the IRS Earnings on a dollar not given to the IRS Copyright ©Houghton Mifflin Company. All rights reserved.

Reduce Taxable Income Via Your Employer Premium only plan Transportation reimbursement plan Copyright ©Houghton Mifflin Company. All rights reserved.

Dependent Care Flexible Spending Account Flexible Spending Account (or FSA or Expense Reimbursement Account) Copyright ©Houghton Mifflin Company. All rights reserved.

Defined-Contribution Retirement Plan 401(k) Retirement Plan Matching Contributions Copyright ©Houghton Mifflin Company. All rights reserved.

Make Tax-Sheltered Investments. Tax-Sheltered Investments: Investments that yield returns that are tax advantaged. Copyright ©Houghton Mifflin Company. All rights reserved.

Reducing Taxable Income: Other Strategies Investing with pretax income Tax-deferred investment growth IRA Roth IRA Copyright ©Houghton Mifflin Company. All rights reserved.

Reducing Taxable Income: Other Strategies Coverdell Education Savings Account Qualified Tuition (Section 529) programs Govt. savings bonds Municipal bonds Copyright ©Houghton Mifflin Company. All rights reserved.

Reducing Taxable Income: Other Strategies Postpone income. Bunch deductions. Take all of your legal tax deductions. Copyright ©Houghton Mifflin Company. All rights reserved.

Top 3 Financial Missteps in Managing Income Taxes People slip up in building and maintaining good credit when they do the following: Turn all you income tax planning over to someone else. Overwithhold too much income to receive a refund next year. Ignore the impact of income taxes in you personal financial planning. Copyright ©Houghton Mifflin Company. All rights reserved.

Good Money Habits in Managing Income Taxes Reduce you income taxes by signing up for tax-advantaged employee benefits at your workplace. Contribute to you employer-sponsored 401(k) retirement plan at least up to the amount of the employer’s matching contribution. Copyright ©Houghton Mifflin Company. All rights reserved.

Good Money Habits in Managing Income Taxes Buy a home to reduce income taxes. Do your own tax return so you can learn how to reduce your income tax liability. Maintain good tax records. Copyright ©Houghton Mifflin Company. All rights reserved.