1. Chapter 3 Taxes in Your Financial Plan McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Taxes in Your Financial Plan Chapter Learning Objectives
LO3.1 Identify the major taxes paid by people in our society
LO3.2 Calculate taxable income and the
amount owed for federal income
tax
LO3.3 Prepare a federal income tax return
LO3.4 Select appropriate tax strategies for various life situations

3. Planning Your Tax Strategy
Learning Objective LO3.1 Identify the Major Taxes Paid by People in Our Society
Planning Your Tax Strategy
Start planning for taxes ….
Know current tax laws as they affect you
Maintain complete and appropriate tax records
Make purchase and investment decisions that reduce your tax liability
Goal: Paying your fair share but still taking
advantage of tax benefits.

4. Types of Taxes Taxes on Purchases Sales tax & excise tax
Taxes on Property
Real estate property tax
Personal property tax
Taxes on Wealth
Federal estate tax
State inheritance tax
Taxes on Earnings
Income tax and Social Security

5. Learning Objective LO3.2 Calculate Taxable Income and the Amount Owed for Federal Income Tax
Step 1: Determine AGI
AGI = Adjusted Gross Income
Taxable Income
Net income = income on which tax is computed
Gross income minus allowable deductions

6. Learning Objective LO3.2 Calculate Taxable Income
Main Components of Gross Income
Earned income
Usually includes wages, salary, commissions, fees, tips, and bonuses
Investment income
Money received in the form of dividends, interest, or rent from investments
Passive income
Results from business activities in which you do not directly participate, such as a limited partnership
Other income
Alimony, awards, lottery winnings, and prizes

7. Learning Objective LO3.2 Calculate Taxable Income
Total income is affected by:
Exclusions
Amounts excluded from gross income
Also referred to as tax-exempt income; income not subject to federal income tax
Example = interest on most state and city bonds
Tax-deferred income
Income that will be taxed at a later date, such as earnings from an traditional individual retirement account (IRA)

8. Learning Objective LO3.2 Calculate Taxable Income
Adjusted gross income (AGI)
Gross income reduced by certain adjustments, described below
The basis for computing various deductions
Adjustments to income
Reduce AGI
Contributions to a traditional IRA or Keogh
Alimony payments

9. Learning Objective LO3.2 Calculate Taxable Income
Step 2: Computing Taxable Income
Tax deduction = amount subtracted from adjusted gross income (AGI) to arrive at taxable income
Standard deduction
Itemized deductions

10. Calculate Taxable Income Itemized Deductions
Medical & dental expenses (>7.5% of AGI)
Taxes
Interest
Contributions
Casualty and theft loses
Moving expenses
Job-related and other miscellaneous expenses

11. Calculate Taxable Income Exemptions
Exemptions  subtracted from AGI
An exemption = a deduction for yourself, your spouse, or qualified dependents
The amount of the exemption for the 2011 tax year is $3,700 per person
After deducting exemptions, you have your taxable income

12. Tax Record-Keeping System

13. Learning Objective LO3.2 Calculate Taxes Owed
Step 3: Calculating taxes owed
Tax table rates = marginal rates
The tax rate paid on the last (or next) dollar of taxable income.
Example:
After deductions and exemptions, a person in the 35% tax bracket pays 35 cents in taxes for every dollar of taxable income in that bracket.

14. 2011 IRS Tax Brackets

15. Tax on a married taxpayer’s income of $90,025
2011 IRS Tax Example
Tax on a married taxpayer’s income of $90,025

16. Learning Objective LO3.2 Calculate Taxes Owed
The average tax rate = the total tax due divided by taxable income
Average tax rate < marginal tax rate
Example:
Taxable income = $90,025
Total tax bill = $14,756
Average tax rate = 16.4%
($14,756 / $90,025)

17. Learning Objective LO3.2 Calculate Taxes Owed
Alternative minimum tax (AMT)
Paid by taxpayers with high amounts of certain deductions and various types of income
Designed to ensure that those who receive tax breaks also pay their fair share of taxes

18. Learning Objective LO3.2 Calculate Taxes Owed
Tax credits
Amount subtracted directly from the amount of taxes owed
Examples:
Earned income credits
Foreign tax credits
Child and dependent care credits
Retirement tax credits
Adoption tax credits
Education credits to offset college education expenses

19. Tax Credit versus Tax Deduction
Reduces Your Taxes by $100
$100 Tax Deduction
Amount Your Taxes are Reduced
is Based on Your Tax Bracket

20. Determining Your Tax Liability

21. Learning Objective LO3.2 Calculate Taxes Owed
Step 4: Making Tax Payments
Payroll Withholding
Based on the number of exemptions and the expected deductions claimed
Estimated Quarterly Payments
Estimated tax payments made throughout the year based on income made during the year and reported on Form 1099.

22. Learning Objective LO3.2 Calculate Taxes Owed
Step 5: Watching Deadlines-Avoiding Penalties
Form 4868  automatic six-month extension
Submit estimated tax due with Form 4868 by April 15
Penalties & Interest
Underpayment of quarterly estimated taxes may require paying interest on the amount owed
Underpayment due to negligence or fraud can result in penalties of 50 to 75 percent

23. Learning Objective LO3.3 Prepare a Federal Income Tax Return
Every citizen or resident of U.S. and every U.S. citizen who is a resident of Puerto Rico is required to file income tax.
Five filing status categories:
Single or legally separated
Married, filing jointly
Married, filing separately
Head of household
Unmarried individual or surviving spouse who has a child or dependent relative
Qualifying widow or widower with a dependent (2 years)

24. Which Tax Form Should You Use?
≈ 800 federal tax forms and schedules
Basically the choice is between 3 forms
1040EZ
1040A
Used by 60%
Which form to use?
Type of income
Amount of income
Number of deductions
Complexity of tax situation
Used by 20% of taxpayers

25. Completing the Federal Income Tax Return
Filing status and exemptions
Income
Adjustments to income
Tax computation
Tax credits
Other taxes (such as from self-employment)
Payments (total withholding and other payments)
Refund or amount you owe
Refunds can be directly deposited to your bank account.
Payments may be directly debited from your bank account.
Your signature = Most common filing error

26. Federal Income Tax Form 1040

27. How Do I File My State Tax Return?
All but 7 states have a state income tax
Most states’ tax rate ranges from 1 to 10 percent
States usually require income tax returns to be filed when the federal income tax return is due

28. How Do I File My Taxes Online?
Tax preparation software
H&R Block At Home (formerly Tax Cut) and TurboTax are two of the most popular tax preparation software packages
Using software can save 10 or more hours
Tax software allows you to complete needed tax forms
Print and mail the forms or file online
e-filing refunds usually take 3 weeks
Cost for e-filing = $5 - $40

29. Selecting Tax Software
Considerations:
Personal situation
Special tax situation
Features in the software
“Audit check”
Future planning
State tax filing online
Technical aspects
Hardware and operating system requirements
Online support

30. How Do I File My Taxes Online?
Free File Alliance
Online tax preparation and filing free to many taxpayers (depends on income)
Go to:
Select: “Free File”
Various qualification criteria to file free; use “Guide Me to a Service”
Connect to selected firm’s website
Use form’s online software to prepare and file tax return

31. Available Tax Assistance Sources
IRS Services
Publications and forms
1-800-TAX-FORM
Recorded messages
Phone hot line
Walk-in service at an IRS office

32. Available Tax Assistance Sources
Tax publications
e.g. Ernst and Young Tax Guide and J.K. Lasser’s Your Income Tax
The Internet
Tax preparation software companies
Tax Preparation Services
Tax preparers charge between $40 and $2,000, depending on the complexity of the return
Over 40 million U.S. taxpayers pay someone else to do their taxes

33. Types of Tax Preparation Services
One-person, local offices to large firms such as H & R Block
“Enrolled agents” = Government-approved tax experts
CPA Tax Accountants
Attorneys

34. Evaluating Tax Services
Factors to consider:
Training and experience of the tax
professional
Fee for preparing taxes and how determined
Questionable deductions suggested?
If return is audited, will the preparer represent the client?
Is tax preparation the main business activity, or is it a front for other financial products?

35. Tax Service Warnings
Ultimately you are responsible for providing complete and accurate information
If your professional tax preparer makes a mistake, you are still responsible for paying the correct amount, plus any interest and penalties.
Hiring a tax preparer does not guarantee that you will pay the correct amount
Beware of tax preparers that offer refunds in advance
“Refund anticipation loans” can charge interest rates in excess of 300%

36. What if Your Return is Audited?
≈ 1.0% of all returns are audited
If you claim large or unusual deductions you are more likely to be audited.
Three types of audits:
Correspondence audit for minor questions
Office audit takes place at an IRS office
Field audit is the most complex, with an IRS agent visiting you at your home, your business or your accountant’s office

37. What if Your Return is Audited?
Audit Rights
Request time to prepare
Clarification of items being questioned
Right to appeal audit results
When Audited:
Decide whether to bring you tax preparer, accountant or lawyer
Be on time for your appointment; bring only relevant documents
Present evidence in a logical, calm, and confident manner; maintain a positive attitude
Make sure your information is consistent with tax law
Keep your answers aimed at the auditor’s questions

38. Learning Objective LO3.4 Select Appropriate Tax Strategies
Tax Planning Strategies
Practice tax avoidance
Legitimate methods to reduce your tax obligation to your fair share but no more
Financial decisions related to purchasing, investing, and retirement planning are the most heavily affected by tax laws
Tax Evasion
Illegally not paying all the taxes you owe, such as not reporting all income

39. Tax Planning Strategies Minimizing Taxes
If you expect
Then you should
Because
The same or a lower tax rate next year
Accelerate deductions into this year
Greater benefit to higher rate
The same tax rate next year
Delay income into next year
Delay paying taxes
A higher tax rate next year
Delay deductions
Greater benefit
Accelerate income
Taxed at lower rate

40. Tax-Planning Strategies Consumer Purchasing
Home ownership
One of the best tax shelters
Deduct mortgage loan interest and property taxes
Reduces your taxable income
Use home equity line of credit to buy a car or consolidate debt
Interest deductible

41. Tax-Planning Strategies Consumer Purchasing
Job-related expenses may be allowed as itemized deductions
Union dues
Business tools
Job search costs
Health care expenses like FSA’s (Flexible Spending Accounts) allow you to reduce your taxable income when paying for health related expenses

42. Tax-Planning Strategies Investment Decisions
Tax Exempt Investments
Interest income from municipal bonds are exempt from federal and some state taxes
Tax Deferred Investments
Tax deferred annuities
Section 529 education savings plans
Retirement Plans -IRA, Keogh or 401(k)
A type of tax shelter

43. Tax-Planning Strategies Investment Decisions
Capital Gains
Profits from the sale of stocks, bonds or real estate
Long-term capital gains (held more than one year) taxed at a lower rate
Self Employment
Advantage: Owning your own business can
have tax advantages
Disadvantage: Business owners have to pay
additional taxes

44. Tax-Planning Strategies Investment Decisions
Children’s Investments
Children under 19 or a full-time student under 24 with investment income of more than $1,900 is taxed at parents’ top rate
Under $1,900 qualifies for a $950 deduction, with remainder taxed at child’s rate
Retirement Plans
- Traditional IRA Roth IRA - Education IRA
- Keogh Plan (K) Plan

45. Changing Tax Strategies
IRS Changes:
IRS modifies tax filing procedures each year
Congress passes legislation to change the tax code each year.
Take advantage of these changes for personal financial planning
Personal Changes:
Consider changes in your personal situation and income
Monitor your tax strategies to best serve your daily needs and long-term financial goals

46. Flat or VAT Tax? Flat tax VAT = Value-Added Tax
All taxpayers pay the same rate
Would increase taxes for many
VAT = Value-Added Tax
Taxes a product at each stage in the manufacturing process
Tends to start small and rise over time

47. Chapter Summary Learning Objective LO3.1
Tax planning can influence spending, saving, borrowing, and investing
decisions.
An awareness of income taxes, sales taxes, excise taxes, property taxes,
estate taxes, inheritance taxes, gift taxes,
and Social Security taxes is vital for successful financial planning.

48. Chapter Summary Learning Objective LO3.2
Taxable income is determined by subtracting adjustments to income, deductions, and allowances for exemptions from gross income.
Your total tax liability is based on the published tax tables or tax schedules, less any tax credits.

49. Chapter Summary Learning Objective LO3.3
The major sections of Form 1040 provide the basic framework for filing your federal income tax return.
Main sources of tax assistance:
IRS services and publications
Other publications
The Internet
Computer software
Professional tax preparers such as commercial tax services, enrolled agents, accountants, and attorneys.

50. Chapter Summary Learning Objective LO3.4
Reduce your tax burden through careful planning and making financial decisions related to consumer purchasing, and the use of debt, investments, and retirement planning.