CHAPTER 3: MANAGING YOUR TAXES

1. CHAPTER 3:MANAGING YOUR TAXES

2. Principles of Federal Income Taxes • Typical American family pays more than one-thirdof its gross income in various types of taxes. • Internal Revenue Service (IRS) is responsible for the administration and enforcement of federal tax laws.

3. Objective of Tax Planning • To maximize the amount of money you keep by minimizing the amount of taxes you pay.

4. What are Taxes? • Complicated laws which are the subject of frequent revision • Used to fund government activities and a wide variety of public services • Dues we pay for membership in our society • Cost of living in this country

5. Economics of Income Taxes: • Federal income taxes are assessed according to a progressive tax structure; • i.e., the larger the taxable income, the higher the tax rate. • The next higher rate applies only to the additional income in that bracket, not to your entire income. • Tax brackets, standard deductions, and personal exemptions are indexed to inflation.

6. 2008 Tax Rate Schedule(single taxpayers) Taxable Income Tax Rate $1 – $8,025 10% $8,026 – $32,550 15% $32,551– $78,850 25% $78,851- $164,550 28% $164,551 – $357,700 33% Over $357,701 35%

7. Example: If you have $90,000 in taxable income, what will your federal income tax liability be?

8. Work through the tax brackets: $8,025 x 10% = $ 803 + ($32,550 – $8,025) x 15% = $ 3,679 + ($78,850 – $32,550) x 25% = $11,575 + ($90,000 – $78,980) x 28% = $ 3,122 Tax Liability = $19,179

9. In the above example, • Your marginal, or stated, tax rate is 28%, the rate of your highest bracket. • Your average tax rate is 16.9%, which is calculated by dividing the amount of taxes paid by your taxable income: $19,179  $90,000 = 21.31%

10. Filing Status • based on your marital status and family situation on the last day of tax year • Is a factor in determining amount of income tax paid • Single • Married filing jointly • Married filing separately • Head of household • Qualifying widow/widower with dependent child(ren) More Principles of Taxation:

11. More Principles of Taxation: • Taxes are due on a pay-as-you-go basis • Employer withholds taxes all year • Self-employed deduct and pay taxes • At time of filing you receive credit for amount already withheld and settle up for the past year • Your income is subject to • Federal income taxes • State income taxes • Local income taxes • Social Security taxes

12. Filing Requirements • Every individual or married couple who earns a specified level of income is required to file a return • If your income falls below prevailing minimum levels, you are not required to file a return • To receive a refund, you must file

13. Federal Withholding Taxes • Amount deducted from gross earnings depends on • Level of earnings • Number of allowances • W-4 form completed by employee tells employer how many allowances your are entitled to • Allowances reduce amount of taxes withheld

14. FICA and Other Withholding Taxes • Federal Insurance Contributions Act (FICA) – 15.3% in 2009 • A combined old-age, survivor’s disability, and hospital insurance • Paid equally by employer and employee (12.4% + 2.9%) • Employee’s share consists of • Social Security (6.2%) - applies only to the first $106,800 • Medicare (1.45%) – paid on all earnings

15. Gross Income • Total of all of taxpayer’s income • Subject to federal taxes • Includes • Wages & salaries • Bonuses, commissions, & tips • Interest & dividends received • Alimony received • Business & farm income • Gains from the sale of assets • Income from pensions & annuities • Income from rents & partnerships • Prizes, lottery & gambling winnings

16. Taxable Income • Amount of our income on which we calculate taxes owed

17. Taxable Income and Liability

18. Taxable Income and Liability

19. Taxable Income and Liability

20. Capital gain (loss) occurs when an asset is sold for more (less) than its original cost. • Short-term capital gain occurs when an item is held for 1 year or less; taxed at ordinary income tax rates. • Long-term capital gain occurs when an item is held longer than 1 year; currently taxed at 15% or less.

21. Adjustments to Gross Income • Items which can be subtracted from gross income. • Adjustments include: • Educator expenses (limited) • Higher education tuition costs (limited) • IRA contributions (limited) • Self-employment tax—50% of amount paid • Self-employment health insurance premiums • Alimony paid • Penalty on early withdrawal of savings • Moving expenses (limited)

22. Adjusted Gross Income (AGI) • Subtotal obtained when adjustments are subtracted from gross income. • Certain itemized deductions and other calculations are limited by this amount.

23. Deductions • The standard deduction is the blanket amount allotted for various deductible expenses taxpayers normally incur. • If your deductible expenses are greater than the standard deduction, you may itemize your deductions instead. • Choose the most advantageous method; itemized deductions must be documented. • At higher income levels, limits are applied to both deductions and exemptions.

24. Deductions:Standard or Itemized Standard deduction – blanket amount allotted for various deductible expenses filing status age vision

25. Itemized deductions are listed on Schedule A and include the following: • Medical and dental expenses (only amount in excess of 7.5% of AGI) • State and local income taxes • Property taxes • Home mortgage interest • Charitable contributions • Casualty and theft losses (very limited) • Job and misc. expenses (only amount in excess of 2% of AGI) • Moving expenses (some restrictions)

26. Deductions:Standard or Itemized Itemized deductions personal expenditures deducted from AGI itemize if expenses are greater than standard deduction Medical, dental expenses State, local income taxes Property taxes Mortgage interest Charitable contributions Casualty, theft losses

27. Exemptions • Amount subtracted based upon the number of people supported by the taxpayer’s income. • You are an exemption on your own return unless you can be claimed by someone else. • Children, spouses, elderly parents are other examples of exemptions. • Each person can be claimed on only 1 tax return!

28. Taxable Income & Tax Calculation • Taxable income is the amount on which the tax calculation is done to determine taxes owed. • If your taxable income is under $100,000, use the tax rate tables. • If greater than $100,000, calculate amount using tax schedules. • Alternative minimum tax is calculated differently; used for higher-income taxpayers.

29. Tax Credits • Subtracted from the amount of taxes you owe • More valuable than a deduction or exemption • Credits include: • Credit for child & dependent care expenses • Education credits • Child tax credit • Adoption credit • Earned income credit (EIC)

30. Tax Credits versus Tax Deductions • Creditsdirectly reduces, dollar for dollar, the amount of taxes due. • Deductions are subtracted from your AGI and reduce your taxable income. • Which results in lower taxes?

31. Gross Income $34,000 $34,000 Other deductions/ exemptions – 6,000 – 6,000 Extra $1000 Deduction – 1,000 – 0 Taxable Income $27,000 $28,000 Taxes Calculated $ 3,685 $ 3,835 $1000 Tax Credit – 0 – 1,000 Tax Liability $ 3,685 $ 2,835 Extra $1000 $1000 Deduction Tax Credit

32. Other Taxes • In addition to federal income taxes, taxpayers with certain situations may be required to pay other taxes at this time. • Self-employed individuals must pay the self-employment tax.

33. Tax Liability • This is the total amount of taxes that you owe. • You subtract any payments already made or withheld from your pay. • If you have overpaid, you may choose to get a refund. • If you have underpaid, you must pay the difference plus any tax penalties.

34. Tax Forms and Schedules • All taxpayers file their returns on some variation of Form 1040. • If more detail is needed, taxpayers will also have to file other forms and schedules. • Frequently used schedules include: • Schedule A (itemized deductions) • Schedule B (interest/dividend income) • Schedule C (personal business income) • Schedule D (capital gains/losses)

35. Other Filing Considerations • Quarterly payment of estimated taxes on other income sources • April 15 filing deadline • Filing extensions • Automatic 6-month • Must estimate taxes due and remit that amount with extension application • Amended returns (1040X) – used to correct a mistake on previously filed return • Audited returns • Questions whether all income received has been properly reported • Questions if the deductions claimed are legitimate and the correct amount

36. Preparing Your Tax Return • Do it yourself • IRS publications/website • Get help from the IRS • Compute taxes for taxable income less than $100,000 and who do not itemize deductions • Use professional services • Tax services (i.e. H&R Block) • Certified public accountants (CPAs) • Enrolled agents (EAs) – Federally licensed people who have passed an IRS administered exam • Tax attorneys • Use tax software • Taxpayer is responsible for accuracy!

37. Effective Tax Planning • Tax avoidance is legal. Tax evasion is not! • Reduce taxes • Use all appropriate deductions or credits. • Use techniques that receive preferential tax treatment, such as depreciation on real estate and tax-exempt income on municipal bonds. • Shift taxes • Use gifts or trusts to shift some of your income to others in lower tax brackets.

38. Defer taxes • Postpone taxes to the future when you may be in a lower tax bracket. • Use retirement plans, IRAs, annuities, life insurance policies, and EE savings bonds.

39. THE END!