Chapter 4 (Tax Planning)

Exemptions

-A deduction allowed by law to reduce the amount of income on tax return. -Includes yourself, spouse, and dependents. -Dependents must qualify as a child under 19 years old or up to 24 years if a full-time college student -Must provide half of dependents support, a citizen of the U.S., Mexico, or Canada

Maximize Deductions—reduce taxable income to its minimum

1. Use tax-deferred retirement programs. 2. Use your home as a tax shelter. 3. Shift and bunch deductions

AGI Deductions

1.) Contribution to qualified retirement accounts (IRA, 401(k), 403b 2.) Interest paid on student loans 3.) Moving Expenses 4.) Alimony Payments 5.) Health Savings Accounts 6.) Half of Social Security/ Medicare for Self Employed Filers 7.) Unreimbursed Educator Expenses K-12 teachers

Schedule A - Itemized Deductions

1.) Medical/ Dental Expenses 2.) State/ Loan Income Taxes 3.) Property Taxes 4.) Mortgage/ Home Equity Loan 5.) Charitable Contributions 6.) Casualty/ Theft Loss 7.) Miscellaneous (unreimbursed job, tax preparation, investment related)

Being Audited

• Audit—an examination of tax return by IRS • Randomly selected—higher odds if itemized deductions are 44% of income. • Asked to send additional information in mail or IRS face-to-face interview. • Reexamine areas in question, get all data and records, appeal audit outcome if necessary.

Long-Term Capital Gains on Homes

• Capital gains taxes for most homeowners on sale of their homes • Exemption up to $500,000 for couples filing jointly ($250,000) filing single on sale of principal residence • Must have been occupied for 2 of the 5 years prior sale

Step 3: Subtracting Deductions

• Choose between standard deduction or itemizing deduction • 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 • Take greater deduction between standard and itemized deduction • Difficult to choose when they are close in value

Other Filing Considerations

• Choosing the right form between 1040EZ, 1040A, or 1040 • Depends on dependents, income, itemizing • File by Mail or Electronic Filing (e-file) • Benefits of e-filing include: - Faster refunds - More accurate returns - Quick electronic confirmation - Delete the paperwork—nothing to mail - Federal/state e-filing

Step 4: Claiming Your Exemptions

• Exemption—deduction for each person supported by the income on a tax return • An exemption includes yourself, spouse or dependents • Dependent must qualify as child or dependent

Filing Late and Amended Returns

• File Late—Form 4868—request an extension if unable to file by April 15th and include estimated tax payment • Amended Return—Form 1040X—file within 3 years of original tax date • Amend the state and local forms as well

Step 2: Calculating Adjusted Gross Income (AGI)

• Gross income less allowable adjustments • Adjustments include: - Tax-deductible contributions - Retirement contributions

Other Taxes

• Income-Based Taxes: - Social Security or FICA - State and local income taxes • Non-income-based taxes - Excise taxes - Property taxes - Gift and estate taxes

5 Tax Strategies to Lower Your Taxes

• Maximize Deductions • Look to Capital gains and dividend income • Shift Income to family members in lower tax brackets • Receive tax exempt income • Defer taxes to the future

Calculating your taxes

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

Paying your Income taxes

• Pay-as-you-go basis • Withholding from wages • Quarterly estimated taxes sent to the IRS • Payments with tax return • Withholdings from stock dividends, retirement funds, and prize winnings • 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. • W-4 form (usually filled out with new employer)—marital status, number of exemptions claimed

Filing Status

• Single • Married Filing Jointly/ Surviving Spouses (Widow) • Married Filing Separately (Single) • Head of Household

Step 1: Determining Gross or Total Income

• Sum of all taxable income from all sources • Active income—income from wages or a business • Portfolio or investment income—securities • Passive income—activities in which the taxpayer does not actively participate

Cost of Living Increases in Tax Brackets, Exemptions, and Deductions

• Tax brackets change annually to reflect changes in the cost of living (inflation) • Standard deductions and personal exemptions are increased to reflect inflation • Bracket Creep—tax increase caused by inflation increasing wages

Step 6: Subtract Your Credits and Determine Your Taxes Due

• Tax credits reduce actual taxes paid and phase out as AGI increases • Child Credit • Education Credits • Child and dependent care credit • Earned income credit • Adoption credit

Step 5: Calculating Your Taxable Income, and From That, Calculating Your Base Income Tax

• Taxable income—subtract deductions and exemptions from AGI • Base income tax—intersection of filing status and taxable income in the federal income tax tables • Use tax rate schedules for taxable income greater than $100,000 • Alternative minimum tax (AMT) ensures that wealthy pay enough taxes

AGI

•Adjusted Gross Income -Taxable income from all sources minus specific adjustments but before deducting standard or itemized Deductions

Marginal Taxes vs. Average Taxes

•Average Tax rate -The average amount of your total income taken away in Taxes •Marginal tax rate (Bracket) -The percentage of the last dollar earned that goes to pay taxes •Tax deferred -income on which the payment of taxes is postponed

Capital Gains/ Dividend Income

•Capital asset -Asset you own •Capital gain -profit you make if you sell a capital asset •Capital loss -What you lose if you sell a capital asset for a loss •Capital gains tax -Tax you pay on your capital gains •Lower tax rate on both the long-term capital gains and on dividends. • Long-term capital gains tax on profits from the sale of stocks and bonds, not gains from sale of collectibles. • Capital gains are not claimed or taxed until the asset is sold.

Tax Credits

•Reduce the amount of taxes paid and phase out as AGI increases •Credits includes: -Children -Education -Child care -Earned income -Child Adoption

Effective Marginal Tax Rate

•The rate you pay when all income taxes are combined (federal, state, city, social security tax, etc.) •Greater than the marginal tax rate on federal income taxes