1 Chapter 4 – Tax Planning Intent – not to make you tax experts –But appreciate major features of tax laws Key concepts – deductions and sheltered income Progressive (graduated) rates –Earn more, pay higher rate

2 Forms 1040 EZ – under $50,000 and no dependents; interest under $1, A – under $50,000 but may have dividends/interest 1040 – “long form”, only one permitting itemized deductions All may be filed electronically Electronic refunds even with paper forms

3 Filing Status Single Married Filing Jointly Married Filing Separately Head of Household –Unmarried with dependents

4 Which Form Did You Use? (Show of Hands) Didn’t have to file 1040 EZ 1040 A 1040 How many used a paid tax preparer? How many filed electronically?

5 Recent Changes Econ Growth and Tax Relief Act –Phases in reduced tax rates affecting all brackets; gave rebates Jobs Growth and Tax Relief Act – 2003 –Dividends and long-term capital gains tax rates reduced to 15% Previously, dividends taxed at ordinary rates (up to 40%) and cap gains at 20%

Rates on Taxable Income (Married filing Jointly) Tax RateIncome Range 10%$1 to $14, ,300 to 58, ,100 to 117, ,250 to 178, ,650 to 319,100 35over 319,100

7 Calculating Taxes Taxes – largest annual expenditure Generally singles file if earn over $7,800 –Lower if you are a dependent or have investment income Gross income less adjustments, standard or itemized deductions and personal exemptions equals taxable income –Use tax tables or rate schedules

$75,000 Taxable Income (Married Filing Jointly) First 10%= $1,430 Next 43,800 6,570 Next 16,900 25% 4,225 $75,000$12,225 * (58, ,300) * 15% = 6,570 ** (75,000 – 58,100) * 25% 4,225

9 Marginal Rate Brackets – rate applied to a range of income Marginal rate – rate on next dollar of income –Important effect on taxes of changing income or deductions –Needed for financial decisions –Include all taxes that change Social Security (FICA), state income taxes

10 Other Taxes On income – FICA, Medicare, state and local income tax Non-income – sales, excise, real and personal property, inheritance

11 Capital Gains Gain or loss on an investment (capital asset) –Stocks, bonds, real estate –Gain/loss – difference of cost and sale price Gains and losses offset each other –Largest net loss deductible is $3,000 Long-term gain rate lower than short-term –15% tax imposed when asset is sold

12 Gross Income Taxable income from all sources: –Wages, salaries and tips –Dividend and interest income and capital gains (Schedules B and D) –IRA distributions and pensions –Rental income, unemployment insurance, some social security and state tax refunds –Equals Total Income – Line 22

13 Adjusted Gross Income Total income less adjustments IRA contribution, health insurance for self- employed, interest on some student loans, medical savings, some moving expenses Equals Adjusted Gross Income (AGI) Lines 36 and 37

14 Tax Impact Retirement Savings 401 (k) Plans – employer sponsored Contributions not included in Line 7 wages Reduces total income, Line 22 Various contribution limits, generally $13,000 Individual Retirement Accounts (IRA) Contributions (Line 25) reduces AGI Deduct $3,000 contribution if not covered by another plan Not taxed until withdrawal; penalty if early

15 Deductions Itemized or standard, whichever fits best –Standard: $4,850 for singles, $9,700 joint –Use Schedule A for itemized deductions AGI less deductions, less $3,100 per person personal exemption, equals taxable income

16 Itemized Deductions Medical (if over 7.5% of AGI) State & local income and property taxes Mortgage interest, points; some HE int. Gifts to charity Casualty and theft losses (limited) Miscellaneous (limited) Total limited if AGI over $140,000

17 Summary Gross Income from all sources + or – Adjustments IRA, student loans, and other adjustments = Adjusted Gross Income (AGI) -Standard or Itemized Deductions - Personal Exemptions = Taxable Income

18 Calculating Taxable Income

19 Other Info Late filing after April 15 –Extension but must pay estimated tax Audits – more likely if earn more – Need good records. Preparation: self-help to part-time "experts" to professionals (CPA's) –Not licensed or tested

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21 Tax Planning I Minimize unnecessary payments Strategy #1 – Maximize deductions –Tax-deferred retirement savings plans –Use home as tax shelter –Shift and bunch deductions

22 Tax Planning II Look to capital gains income –Long-term gains tax rate lower (15%) Shift income to family members in lower brackets –Big risk – lost control over kids’ spending Receive tax-exempt income (municipals) Defer taxes through retirement accounts

23 Web Readings Next Class Savings Bonds E-payments (see Assignments) Go to Click Savings Bond Wizard – left column Click More about Savings Bonds (on left) Click Bond Owner Manual (center)