1. Chapter 4 Tax Planning and Strategies Tax Planning and Strategies

2. Introduction Most financial decisions are affected by taxes. Most financial decisions are affected by taxes. Need to understand how taxes are imposed. 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? What strategies are used to reduce taxes and what role does tax planning have in personal financial planning?

3. How It All Began 16 th Amendment, 1913 16 th Amendment, 1913 Tax Rate: 1-6% Tax Rate: 1-6% Only about 1% of the population had to pay taxes Only about 1% of the population had to pay taxes

4. Taxes Impact Our Lives and Financial Plan YearDayYearDay 1950 March 29 1995 April 23 1955 April 1 1996 April 24 1960 April 8 1997 April 26 1965 April 5 1998 April 27 1970 April 16 1999 April 28 1975 April 14 2000 April 30 1980 April 19 2001 April 27 1985 April 10 2002 April 19 1990 April 20 2003 April 19

5. The Federal Income Tax Structure Progressive or graduate tax—tax rises as income rises Progressive or graduate tax—tax rises as income rises Tax rates and tax brackets —Table 4.1 (page 90) Tax rates and tax brackets —Table 4.1 (page 90) Income ranges in which the same marginal tax rates apply Income ranges in which the same marginal tax rates apply 10%-35% of Earnings 10%-35% of Earnings Personal exemption Personal exemption Itemized or standard deductions Itemized or standard deductions Taxable income Taxable income

6. Table 4.1

7. Paying Your Income Taxes Pay-as-you-go basis. Pay-as-you-go basis. Withholding from wages. Withholding from wages. Quarterly estimated taxes sent to the IRS Quarterly estimated taxes sent to the IRS Payments with tax return Payments with tax return Withholdings from stock dividends, retirement funds, and prize winnings. Withholdings from stock dividends, retirement funds, and prize winnings.

8. Paying Your Income Taxes You have some control over how much is deducted for taxes from your wages. 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. 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 W-4 form (usually filled out with new employer)—marital status, number of exemptions claimed

9. Tax Forms Used By Employers W4 W4

10. Calculating Your Taxes Must you file a tax return? Must you file a tax return? Depends on income, filing status, age, whether you can be claimed as dependent. Depends on income, filing status, age, whether you can be claimed as dependent. Dependent—person you support financially. Dependent—person you support financially. Calculate taxes anyway to get any refund due to you. Calculate taxes anyway to get any refund due to you.

11. Step 1: Determining Gross or Total Income Sum of all taxable income from all sources. Sum of all taxable income from all sources. Active income—income from wages or a business Active income—income from wages or a business Portfolio or investment income--securities Portfolio or investment income--securities Passive income—activities in which the taxpayer does not actively participate Passive income—activities in which the taxpayer does not actively participate

12. What Is Taxable? Wages Wages Salaries Salaries Tips Tips Alimony Alimony Capital Gains Capital Gains Interest Interest Dividend Dividend

13. Step 2: Calculating Adjusted Gross Income (AGI) Gross income less allowable adjustments Gross income less allowable adjustments Adjustments include: Adjustments include: Tax-deductible contributions Tax-deductible contributions Retirement contributions Retirement contributions

14. Step 3: Subtracting Deductions Choose between standard deduction or itemizing deduction. Choose between standard deduction or itemizing deduction. Itemize deductions—list of deductible expenses: medical expenses, tax expenses, mortgage interest payments, etc. 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. Standard deduction—government’s best estimate of what the average person would deduct if itemizing.

15. Figure 4.3

16. Step 4: Claiming Your Exemptions Exemption—deduction for each person supported by the income on a tax return. Exemption—deduction for each person supported by the income on a tax return. An exemption includes yourself, spouse or dependents. An exemption includes yourself, spouse or dependents. Dependent must qualify as child or dependent. Dependent must qualify as child or dependent.

17. How To Reduce Taxes: Exemptions Exemptions Personal Personal Your Dependents Your Dependents Deductions Deductions Standard Itemized Mortgage interest Other taxes Large medical & dental expenses Charities

18. Step 5: Calculating Your Taxable Income, and From That, Calculating Your Base Income Tax Taxable income—subtract deductions and exemptions from AGI Taxable income—subtract deductions and exemptions from AGI Base income tax—intersection of filing status and taxable income in the federal income tax tables. Base income tax—intersection of filing status and taxable income in the federal income tax tables.

19. Figure 4.5

20. Step 6: Subtract Your Credits and Determine Your Taxes Due Tax credits reduce actual taxes paid. Tax credits reduce actual taxes paid. Tax credits phase out as AGI increases. Tax credits phase out as AGI increases. Child Credit Child Credit Education Credits Education Credits Child and dependent care credit Child and dependent care credit Earned income credit Earned income credit Adoption credit Adoption credit

21. How Can I Reduce Tax Bill? Credits—offset your taxes, they don’t merely reduce your taxable income, they offset taxes. Credits—offset your taxes, they don’t merely reduce your taxable income, they offset taxes. Child Credit Child Credit The Hope Scholarship Tax Credit The Hope Scholarship Tax Credit Lifetime Learning Credit Lifetime Learning Credit Child and Dependent Care Credit Child and Dependent Care Credit Earned Income Credit Earned Income Credit Adoption Credit Adoption Credit

22. Status Single—no dependents Single—no dependents Married Jointly Married Jointly Married Separately Married Separately Head of Household—dependents Head of Household—dependents

23. Other Filing Considerations Choosing the right form between 1040EZ, 1040A, or 1040 Choosing the right form between 1040EZ, 1040A, or 1040 Depends on dependents, income, itemizing. Depends on dependents, income, itemizing.

24. Forms 1040: Long form, itemized deductions, complex income 1040: Long form, itemized deductions, complex income 1040A: Short form, standard deduction 1040A: Short form, standard deduction 1040EZ: simple form, standard deduction, <$50,000, no dependents 1040EZ: simple form, standard deduction, <$50,000, no dependents

25. Fill in your name, your spouses name, and address Fill in your SSN and your spouses SSN If you wish to donate to the presidential election, check here

26. 1.Fill in the wages amount from W-2 2. Taxable interest Add lines 1+2 Enter $ Subtract line 5 from 4 $7700

27. Tax Forms Used By Employers W-2 W-2

28. 7. Income tax withheld 10. Use amount from line 6 to find your tax on a tax table and enter The amount on line 10 9.. Add 7 and 8. These are your total payments.9. 10. TAX. Use the amount on line 6 above to find your tax in the tax table on pages 25-29 of the booklet. Then enter the tax from the table on this line10. 11a. If line 9 is larger than line 10, subtract line 10 from line 9. 11a 11a. Subtract line 10 from line 9 Add line 7 and 8