Chapter 4- Personal Finance-Planning your Tax Strategies

Income included in gross income

Earned Income-Includes wages, salary, commissions, fees, tips or bonuses Investment income- (also known as portfolio income) is money from dividends, interest, or rent from investments Passive income is from business activities in which you do not actively participate, such as a limited partnership Other income includes alimony, awards, lottery winnings, and prizes

Types of Income Excluded from Gross Income

Exclusions are amounts NOT included in gross income; for example, a portion of foreign earned income -exclusions can also be tax-exempt income, which is income not subject to federal income tax, for example, interest earned on most state and city bonds

Illegal: Do not practice Tax Evasion

Illegally not paying all the taxes you owe, such as not reporting all income

Tax deferred

Income that will be taxed at a later date; for example, earnings on a individual retirement account (IRA)

Taxable income

net income, after deductions, on which income tax is computed

Tax credit

An amount subtracted directly from the amount of taxes owed $100 tax credit reduces your taxes by $100 $100 tax deduction reduces your taxes by $24 if you are in a 24% tax bracket

Adjusted Gross Income (AGI)

Gross income after certain reductions have been made. These reductions are called adjustments to income and include the following: -Contributions to an IRA or KEOGH retirement plan -Penalties for early withdrawal of savings -Alimony pmt -Tax-deferred retirement plans are a type of tax shelter

Average Tax Rate

Based on the total tax due divided by taxable income The average tax rate is less than a person's marginal tax rate Tax due / Income = %

Tax audit

detailed examination of your tax return by the IRS About 1% of all tax filers are audited

Tax-Exempt Investments

-Interest income form municipal bonds is not subject to federal income taxes -Interest on EE savings bonds is exempt from federal income tax if used for tuition

Legal: 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-Deferred Investments

-annuities -Retirement plans Section 529 savings plans for a child's education Capital gains are profits from sale of stocks, bonds, or real estate; taxes paid when sold

Calculating Taxable Income

1. Gross income 2. Less adjustments to income 3. Equals AGI 4. Less greater of Itemized or standard deduction 5. Equals taxable income

Must file?

Single - 12,000 MFJ - 24,000 MFS - 12,000 HOH - 18,000 Qualifying widow (2yrs) 24,000

Marginal Tax Rates

The last (and next) dollar of taxable income

Flexible spending accounts

allow you to reduce your taxable income when paying for medical expenses or child care costs

Tax deduction

an amount subtracted from AGI to arrive at taxable income -Subtract greater of standard deduction or itemized deduction Itemized medical (7.5% of AGI) Can only deduct $10,000 with all these together for taxes and state & local

Exemption

is a deduction for yourself, your spouse, and qualified dependents