CHAPTER 11 The Basic Federal Income Tax Structure Chapter 11: Tax Structure 1

INTRODUCTION  Method of tax computation can help a taxpayer  utilize all allowable deductions to reduce taxes  develop tax planning strategies to minimize long-term tax liability  avoid violating tax limits or rules  make improved financial decisions with full consideration of tax implications Chapter 11: Tax Structure 2

Basic Income Tax Structure Figure 11-1 Basic Income Tax Structure Chapter 11: Tax Structure 3

COMPUTATION OF FEDERAL TAXABLE INCOME  Calculation of Gross Income  Earned Income  W2 / 1099  Portfolio Income  Interest  1099-INT  Dividends  1099-DIV  Report separate if exceeds $1,500  Max 15%  Capital Gains and Losses  Capital Gains Tax Rates Chapter 11: Tax Structure 4

COMPUTATION OF FEDERAL TAXABLE INCOME (Contd.)  Calculation of Gross Income Contd.)  Long-term vs. Short-term Gains or Losses  Long-term = 365 days + 1  Current tax rate max of 15%  Wash Sales  Cannot take loss on an asset that is “replaced” with a similar asset within 30 days prior to or after a sale  61 days  Capital Gains and Sale of Residence  House for Sale  MFJ 500,000 of profit is tax free  Could include vacation home  Renews every 2 years  Selling at a Loss  No deduction for selling at a loss Chapter 11: Tax Structure 5

Capital Gains Tax Calculation Figure 11-2 Capital Gains Tax Calculation Chapter 11: Tax Structure 6

COMPUTATION OF FEDERAL TAXABLE INCOME (Contd.)  Passive Income  Tax shelters etc as long as no material participation  Can only offset passive gains with passive losses  Passive losses can be carried forward  Real estate exception  If own at least 10%, make decisions, and AGI < 100K  Can use up to 25,000 to offset regular income  Miscellaneous Income  Tax-exempt Income: Municipal Bonds  Exempt from federal taxes and state taxes if purchased from resident state.  Social Security Income  Might be taxable  Non-taxable Income  Gifts  Death benefits Chapter 11: Tax Structure 7

Allowable Deduction of Real Estate Losses Table 11-1 Allowable Deduction of Real Estate Losses Chapter 11: Tax Structure 8

Tax-exempt Yields and Equivalent Taxable Yields Table 11-2 Tax-Exempt Yields and Equivalent Taxable Yields Chapter 11: Tax Structure 9 Use to compare the yield on a muni to the yield on a govt or corp bond. Take the yield on a muni, compare to the yield displayed for your tax bracket. If muni yield greater, buy the muni. If the other yield is greater, buy the govt or corporate bond.

Calculate taxable equivalent yield Chapter 11: Tax Structure 10

COMPUTATION OF FEDERAL TAXABLE INCOME (Contd.)  Deductions  Standard Deduction  Itemized Deductions o Medical Expenses o State and Local Taxes o Interest Expense o Charitable Contributions o Business Use of a Home o Casualty or Theft Losses o Moving Expenses o Miscellaneous Expenses  Exemptions  Number of Dependents Chapter 11: Tax Structure 11

Standard Deductions  Standard Deduction  Amount  Age 65 or Blind  Dependents Chapter 11: Tax Structure 12

COMPUTATION OF INCOME TAX  Basic Computation  Marginal Tax Rate  Tax Credits  Child and Dependent Care Credit  Earned Income Credit  Education Credits  Saver’s Credit  Child Tax Credit  Alternative Minimum Tax Chapter 11: Tax Structure 13

Income Tax Table Chapter 11: Tax Structure 14 Income Tax Table for 2012

CALCULATING TAXABLE INCOME Chapter 11: Tax Structure 15

Computation of Alternative Minimum Tax Figure 11-3 Computation of Alternative Minimum Tax Chapter 11: Tax Structure 16

EDUCATION PROVISIONS  Modification of Education IRAs  Coverdell Education Savings Accounts  Maximum $2,000  Qualified Tuition Programs  Section 529  Employer-Provided Educational Assistance  Maximum allowed is 5,250  Extended to graduate programs also  Student Loan Interest Deduction  Up to $2,500 of interest deductible  Whether you itemize or not  Deduction for Higher Education Expenses  Cannot claim when Hope or Lifetime Learning credit is claimed Chapter 11: Tax Structure 17

TAXATION OF CORPORATIONS  C Corporations  The Tax Relief Act of 2001 left intact the current corporate tax rate schedule for the majority of C corporations  S Corporations  If a person owns a closely held business, an S election should be investigated  S corporations may be preferable because of the potential for a double tax on the ultimate sale by a C corporation of its assets with a resulting liquidation.  Using S corporations does have drawbacks Chapter 11: Tax Structure 18