1. Tax Planning and Strategies

2. 4-2 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Learning Objectives 1. Identify and understand the major federal income tax features that affect all taxpayers. 2. Describe other taxes that must pay. 3. Understand what is taxable income and how taxes are determined.

3. 4-3 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Learning Objectives 4. Choose the tax form that’s right for you, file and survive an audit if necessary. 5. Calculate your income taxes. 6. Minimize your taxes.

4. 4-4 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Introduction Most financial decisions are affected by taxes. Need to understand how taxes are imposed. What strategies are used to reduce taxes and what role does tax planning have in personal financial planning?

5. 4-5 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall The Federal Income Tax Structure Progressive or graduate tax Tax rates and tax brackets Personal exemption Itemized or standard deductions Taxable income

6. 4-6 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall The Federal Income Tax Structure Taxable income is a function of adjusted gross income (AGI), deductions, and exemptions. AGI = taxable income from all sources minus specific adjustments but before deducting standard or itemized deductions

7. 4-7 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Table 4.1

8. 4-8 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall The Federal Income Tax Structure Assume you are in the 15% tax bracket. Does that mean you pay 15% of your taxable income in taxes? The last dollar earned is taxed at 15%. Earlier income is taxed at the lower rate.

9. 4-9 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Marginal Versus Average Taxes Average Tax Rate—the average amount of your total income taken away in taxes. Marginal Tax Rate (or marginal tax bracket)—the percentage of the last dollar earned that goes to pay taxes. Tax-deferred—income on which the payment of taxes is postponed

10. 4-10 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Figure 4.1

11. 4-11 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Effective Marginal Tax Rate The rate you pay when all income taxes are combined (federal, state, city, Social Security taxes, etc) Is greater than the marginal tax rate on federal income taxes.

12. 4-12 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Capital Gains and Dividend Income Capital asset—an asset your own Capital gain—what you make if you sell a capital asset for a profit Capital loss—what you lose when you sell a capital asset for a loss. Capital gains tax—tax you pay on your capital gains

13. 4-13 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Capital Gains and Dividend Income Lower tax rate on both the long-term capital gains and on dividends. Long-term capital gains tax on profits from the sale of stocks and bonds, not gains from sale of collectibles. Capital gains are not claimed or taxed until the asset is sold.

14. 4-14 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Long-Term Capital Gains on Homes Capital gains taxes for most homeowners on sale of their homes Exemption up to $500,000 for couples filing jointly ($250,000) filing single on sale of principal residence. Must have been occupied for 2 of the 5 years prior sale

15. 4-15 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Filing Status Single Married Filing Jointly and Surviving Spouses Married Filing Separately Head of Household

16. 4-16 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Cost of Living Increases in Tax Brackets, Exemptions, and Deductions Tax brackets change annually to reflect changes in the cost of living (inflation). Standard deductions and personal exemptions are increased to reflect inflation. Bracket Creep—tax increase caused by inflation increasing wages

17. 4-17 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Paying Your Income Taxes Pay-as-you-go basis. Withholding from wages. Quarterly estimated taxes sent to the IRS Payments with tax return Withholdings from stock dividends, retirement funds, and prize winnings.

18. 4-18 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Paying Your Income Taxes You have some control over how much is deducted for taxes from your wages. Withholdings are determined by income level and information on W-4 form. W-4 form (usually filled out with new employer)—marital status, number of exemptions claimed

19. 4-19 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Other Taxes Income-Based Taxes: Social Security or FICA State and local income taxes Non-income-based taxes Excise taxes Property taxes Gift and estate taxes

20. 4-20 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Calculating Your Taxes Must you file a tax return? Depends on income, filing status, age, whether you can be claimed as dependent. Dependent—person you support financially. Calculate taxes anyway to get any refund due to you.

21. 4-21 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall

22. 4-22 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Step 1: Determining Gross or Total Income Sum of all taxable income from all sources. Active income—income from wages or a business Portfolio or investment income--securities Passive income—activities in which the taxpayer does not actively participate

23. 4-23 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Step 2: Calculating Adjusted Gross Income (AGI) Gross income less allowable adjustments Adjustments include: Tax-deductible contributions Retirement contributions

24. 4-24 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Step 3: Subtracting Deductions Choose between standard deduction or itemizing deduction. Itemize deductions—list of deductible expenses: medical expenses, tax expenses, mortgage interest payments, etc. Standard deduction—government’s best estimate of what the average person would deduct if itemizing.

25. 4-25 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Figure 4.3

26. 4-26 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Step 3: Subtracting Deductions Take greater deduction between standard and itemized deduction. Difficult to choose when they are close in value.

27. 4-27 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Step 4: Claiming Your Exemptions Exemption—deduction for each person supported by the income on a tax return. An exemption includes yourself, spouse or dependents. Dependent must qualify as child or dependent.

28. 4-28 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Step 5: Calculating Your Taxable Income, and From That, Calculating Your Base Income Tax Taxable income—subtract deductions and exemptions from AGI Base income tax—intersection of filing status and taxable income in the federal income tax tables. Use tax rate schedules for taxable income greater than $100,000). Alternative minimum tax (ATM) ensures that wealthy pay enough taxes.

29. 4-29 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Figure 4.4

30. 4-30 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Figure 4.5

31. 4-31 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Step 6: Subtract Your Credits and Determine Your Taxes Due Tax credits reduce actual taxes paid. Tax credits phase out as AGI increases. Child Credit Education Credits Child and dependent care credit Earned income credit Adoption credit

32. 4-32 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Table 4.2

33. 4-33 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Other Filing Considerations Choosing the right form between 1040EZ, 1040A, or 1040 Depends on dependents, income, itemizing.

34. 4-34 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Checklist 4.1 & Checklist 4.2

35. 4-35 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Table 4.3

36. 4-36 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Other Filing Considerations File by Mail or Electronic Filing (e-file) Benefits of e-filing include: Faster refunds More accurate returns Quick electronic confirmation Delete the paperwork—nothing to mail Federal/state e-filing

37. 4-37 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Filing Late and Amended Returns File Late – Form 4868 - request an extension if unable to file by April 15 th and include estimated tax payment. Amended Return - Form 1040X – file within 3 years of original tax date. Amend the state and local forms as well.

38. 4-38 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Being Audited Audit—an examination of tax return by IRS Randomly selected—higher odds if itemized deductions are 44% of income. Asked to send additional information in mail or IRS face-to-face interview. Reexamine areas in question, get all data and records, appeal audit outcome if necessary.

39. 4-39 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Help in Preparing Taxes Handle taxes by yourself. Use IRS publications, IRS hotlines, & self- help publications and computer programs. Hire a tax specialist

40. 4-40 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Model Taxpayers: The Taylors File Their 2007 Return Chuck and Dianne Taylor Using the various steps in calculating taxes for Form 1040

41. 4-41 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Figure 4.6

42. 4-42 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Figure 4.7

43. 4-43 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Tax Strategies to Lower Your Taxes Tax planning must be done ahead of time to minimize unnecessary tax payments. Tax strategies should supplement a solid investment strategy. There are five general tax stragies.

44. 4-44 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Maximize Deductions—reduce taxable income to its minimum 1. Use tax-deferred retirement programs. 2. Use your home as a tax shelter. 3. Shift and bunch deductionss

45. 4-45 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Look to Capital Gains and Dividend Income 15% is the maximum tax rate for long- term capital gains for taxpayers in tax brackets that exceed 15%. Don’t have to claim capital gains until asset is sold. Qualified dividends from corporations are taxed at same low rates as long-term capital gains.

46. 4-46 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Shift Income to Family Members in Lower Tax Brackets Can be complex and involve lawyers and establishment of trusts. Simpler way is to make gifts—recipients do not pay taxes on gifts either. Allowed $12,000 in total gifts per year. Gift some of your estate while still alive.

47. 4-47 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Receive Tax-Exempt Income Interest from state and local government debt such as bonds is tax-exempt The higher your marginal tax bracket, the more beneficial tax-free income is.

48. 4-48 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Defer Taxes to the Future Tax-deferred retirement plans allow your to defer tax payments to the future. Roth IRAs allows taxes to be paid on contributions and never again. Capital gains taxes are postponed until you sell the asset.

49. 4-49 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Summary Taxable income is a function of AGI, deductions and exemptions. Apart from federal income tax, there are Social Security and Medicare taxes, state and local taxes, excise, sales, property, and gift and estate taxes. To calculate taxes, determine total income, adjusted gross income, taxable income, then the taxes your owe.

50. 4-50 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall Summary It is important to know if you must file a return, when to file, use the right form, and the information needed for the return. Obtain the help you need for filing returns from the IRS, self-help tax books and computer programs and tax specialists. There are five general strategies that can be used to reduce taxes to a minmum.

51. 4-51 Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.