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Chapter 12: Planning Your Tax Strategy

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Chapter 12: Planning Your Tax Strategy. Section 12.1 Income Tax Fundamentals. Today’s Agenda: The importance of tax planning How to identify your taxable income The difference between deductions and credits The W-4 form Goal: Learn basic income tax terminology. “Tax Freedom Day”

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Chapter 12: Planning Your Tax Strategy

Section 12.1 Income Tax Fundamentals

  • Today’s Agenda:
    • The importance of tax planning
    • How to identify your taxable income
    • The difference between deductions and credits
    • The W-4 form
  • Goal:
    • Learn basic income tax terminology
“Tax Freedom Day”
  • Tax strategies help with financial planning
    • Learn how current tax laws affect you
    • Keep accurate tax records
    • Learn how to make decisions that reduce
    • your tax liability

Taxes are an everyday occurrence!

What do taxes pay for?

Pay your FAIR SHARE and NO MORE!

    • Taxes on Purchases (Sales Tax)
    • Taxes on Property / Home
      • Real estate property tax: based on value of land and buildings
    • Taxes on Wealth
      • Federal Estate Tax: based on entire value of property at death
      • State Inheritance Tax: based on value of property willed to a specific heir
      • Federal Gift Tax: money or property valued at $13,000 or more (2010)… who pays?
Taxes on Earnings
  • Income tax: a tax on our earnings
  • The IRS: federal agency that collects these taxes
  • The Basics of How it Works:
    • Employer withholds (takes out) income taxes and Social Security taxes from paychecks, sends to IRS
    • Year-end: use a tax form to calculate what you SHOULD HAVE PAID (your tax liability)
    • determine if you have over/under paid
  • You are calculating your
  • TAXABLE INCOME to find your
  • TAX LIABILITY (the amount you should have paid)

TAXABLE INCOME is based on your income, plus many other factors.

You start with your income, and work it DOWN, DOWN, DOWN to find your TAXABLE INCOME.

1. Add up Gross Income
  • Earned income from your job
  • Interest income from savings
  • Dividend income from investments

(Some types of income are not taxed)

  • Exclusions = tax-exempt income
  • Tax-deferred income = income taxed at later date
2. Adjustments to Income
  • Certain items are allowed to be subtracted from your income

Gross Income – Adjustments =

Adjusted Gross Income


3. Tax Deductions

  • Certain expenses that you can subtract from your AGI
Standard vs. Itemized Tax Deductions
  • Every taxpayer can subtract at least the standard deduction
  • Are you eligible for more deductions, above the standard amount?
  • “Itemize” your deductions if the amount is more than the standard deduction
  • Medical and dental expenses that exceed 7.5% of your AGI
  • Real estate property taxes
  • Mortgage interest
  • Charitable contributions
  • Certain expenses incurred from your job
4. Exemptions
  • Allows a specific reduction in AGI per person (you, spouse, each dependent)
  • What is a qualified dependent? Pg.


5. Calculating Your Tax Liability:

AGI – Deductions – Exemptions =

Taxable Income

  • Your taxable income is used to determine your tax liability
  • Use a Tax Table (based on six tax rates)

Figure 12.1

6. Tax Credits
  • If eligible, allows further reductions in your taxes!
  • Subtract directly from your tax liability (different than tax deduction)
  • Dollar-for-dollar savings
  • Examples:
    • EIC = earned income credit for lower-income workers
    • Child Tax credit = credit for people with children
6. Your Total Tax Liability
  • After CREDITS are SUBTRACTED, you arrive at Total Tax Liability
  • Compare this amount to what you paid in taxes the prior year
  • Did you pay enough?
  • Did you pay too much?
Payroll Withholding
  • The number of allowances claimed on the W-4 form determines the amount of federal income tax withheld
  • Use the Personal Allowances Worksheet to figure out how many allowances to claim
  • Claim “0” => higher amount withheld
  • Claim “exempt” => no taxes withheld
  • How to fill out a W-4 form

Figure 12.2

Claiming Allowances
  • Some people like to claim “0” allowances, making withholding amounts greater
  • What is their reasoning?
  • How is this a forced form of savings?
  • Disadvantage of this?
  • What is a better alternative?
  • How will my allowances affect my paycheck?
What is a Dependent?
  • Someone is considered a “dependent” if:
      • Son, daughter, stepchild, foster child
      • Under age 19 OR
      • If full-time student, under age 24
      • Lived with you more than half the year
      • Not provided more than half of own support
  • Dependents must file a tax return if their income is over $5700
  • Dependents cannot claim themselves as an exemption
The 1040EZ
  • The simplest income tax return
  • Who can file?
    • Can be single or married
    • Must be under age 65
    • No dependents
    • Under $100,000 income
  • If eligible to file the EZ form, why might some people file a longer form?