PFIN 4 Preparing Your Taxes 3 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. GITMAN/ JOEHNK/ BILLINGSLEY

1. Define Taxes.

Taxes 3 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Dues paid for membership in a society Cost of living in a country Objective of tax planning Maximize the amount of money that one can keep by legally minimizing the amount one pays PFIN4 | CH3

Income Taxes 4 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Type of tax levied on taxable income by the federal, state, and local governments Progressive tax structure: Larger the amount of taxable income higher the rate at which it is taxed Marginal tax rate: Paid on the next dollar of taxable income Average tax rate: Rate at which each dollar of taxable income is taxed on average Calculated by dividing the tax liability by taxable income PFIN4 | CH3

Take-Home Pay 5 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Employer withholds a portion of income every pay period and sends it to the IRS to be credited to the tax account Employer withholds funds for federal income taxes and for FICA (Social Security) taxes Other payroll deductions Life and health insurance, savings plans, retirement programs, professional or union dues, and charitable contributions PFIN4 | CH3

Taxable Income 6 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Amount of income subject to taxes Gross income: Total of taxpayer’s income subject to federal taxes that includes: Active income Portfolio income Passive income PFIN4 | CH3

2. What are the components of the Taxable Income?

Components of Taxable Income – Gross Income – all income subject to federal taxes – Adjustments to Gross Income – Deductions – Exemptions

Three Kinds of Income Active Income Wages, salaries, bonuses, pension, alimony Interest, dividends, capital gains Portfolio Income Passive Income Income from real estate, limited partnerships

Exhibit Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Capital Gains Tax Categories as of 2013 PFIN4 | CH3

Adjustments to (Gross) Income 11 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Allowable deductions from gross income Educator expenses (limited), higher education tuition costs (limited), IRA contributions (limited), self-employment taxes paid, self- employed health insurance payments Adjusted gross income (AGI) Amount of income that remains after subtracting all allowable adjustments to income from gross income PFIN4 | CH3

Adjustments to Gross Income These can be subtracted from gross income Higher education (limited)IRA contributions (limited)Self-employment tax – (limited to 50%)Alimony paidPenalty on early withdrawal of savingsMoving expenses (limited)

Deductions 13 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. PFIN4 | CH3 Blanket deduction that depends on the taxpayer’s filing status, age, and vision Standard Personal expenditures that can be deducted from AGI when determining taxable income Itemized

Deductions: Standard or Itemized Itemized deductions specific personal expenditures itemize if expenses are greater than standard deduction Medical, dental expenses State, local, foreign taxes Mortgage interest Charitable contributions Casualty and theft losses Moving expenses

Exemptions 15 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Deductions from AGI based on the number of persons supported by the taxpayer’s income Can be claimed for oneself, his/her spouse, and dependents Personal exemption can be claimed only once PFIN4 | CH3

Categories of Filing Status 16 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Single taxpayers Married filing jointly Married filing separately Head of household Qualifying widow or widower with dependent child PFIN4 | CH3

3. What are the steps in filing your taxes?

Gross Income Adjustments Adjusted Gross Income (AGI) Adjusted Gross Income (AGI) Taxable Income Tax to be paid Tax Credits Tax Withheld Tax Refund/ Payments Tax Refund/ Payments Exemptions Subtract Equals Subtract Tax Deductions Subtract Equals Subtract Equals

4. Define Tax Credits and Tax Deductions.

Tax Credits and Tax Deduction – Tax Credits Directly reduces the taxes you owe – Tax Deductions Reduces your taxable income

Tax Credits Subtracted from amount of taxes owed Credits include: Child & dependent care expenses Adoption credit Foreign tax credit Qualified electric car

Tax Credits versus Tax Deductions Which results in lower taxes? Credits directly reduce amount of taxes owed Deductions subtracted from AGI and reduce taxable income VS

Tax Credits versus Tax Deductions A $1000 tax credit reduces tax by much more than a deduction

5. What are some of the tools used for tax planning?

Tax Preparation Services 25 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. National and local tax services Certified public accountants (CPAs) Enrolled agents (EAs) Tax attorneys Computer-based tax returns PFIN4 | CH3

Filing Considerations 26 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Estimated taxes: Payments required on income not subject to withholding that are paid in four instalments Usual filing deadline is April 15 PFIN4 | CH3

Filing Considerations 27 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. PFIN4 | CH3 Time beyond the usual April 15 deadline during which taxpayers can file their returns without incurring penalties File extension Filed to adjust for information received after the filing date of the taxpayer’s original return or to correct errors Amended return Examination by the IRS to validate the accuracy of a given tax return Tax audit

Effective Tax Planning 28 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Tax evasion: Illegal act of failing to accurately report income or deductions and failing to pay taxes Tax avoidance: Act of reducing taxes in ways that are legal and compatible with the intent of Congress Objectives of tax planning To reduce taxes To shift taxes To defer taxes PFIN4 | CH3

Tax Strategies 29 Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Maximizing deductions - Bunch deductions into one tax year if this allows you to itemize rather than take the standard deduction Income shifting: Taxpayer shifts a portion of income to relatives in lower tax brackets Tax-free and tax-deferred income Some investments like municipal bonds provide tax-free income Tax deferred: income that is not subject to taxes immediately but that will later be subject to taxes PFIN4 | CH3