Chapter 3: Taxes in Your Financial Plan

if Mary owes the IRS $5,000 for her income taxes and is in the 15% marginal tax bracket, what would be her average tax rate if she had taxable income of $41,667?

About 12%

Workers under age 50 can contribute up to _____ in their 401k (as of 2017)

$18,000

the normal contribution limit for an IRA for workers under age 50 (as of 2017) is

$5,500

Types of Audits

Correspondence Audit Office Audit (requires visiting the IRS) Field Audit (more complex, requires home visits)

Which best describes how taxpayers pay their taxes to the IRS?

It is a pay-as-you-go system utilizing withholding of tax from paychecks and estimated quarterly payments

Flexible Spending Account (FSA)

allow you to reduce taxable income when paying for medical & dependent care expenses

tax credit

an amount subtracted directly from the tax owed

tax deduction

an amount subtracted from adjusted gross income to arrive at taxable income

tax exemption

an amount you can exclude from income

tax advantages of being self-employed

deductions on costs of certain health and life insurance as a business expense

a recent tax strategy employed by the government is to provide a tax credit for premiums paid for health care, when purchased through the health care

exchanges

John owed $10,000 in taxes on taxable income of $40,000. If John earns an additional $1,000, he will pay an additional $280. Therefore

his average tax rate is about 25%

estate tax

imposed on the value of a person's property at the time of death

what payments are reported on Form 1099?

income from savings, investments, independent contracting, royalties, pension payments

taxable income

income on which tax must be paid; total income minus exemptions and deductions

taxes on earnings

income tax and social security

You calculate taxable income by reducing gross income by adjustments, exemptions, and standard or _______ deductions

itemized

tax planning and strategy

knowing current tax laws, maintaining complete/appropriate tax records, making purchase and investment decisions that can reduce your tax liability

What are tax deductible expenses related to home ownership?

mortgage interest and real estate taxes

Keogh Plan

retirement plan that allows self-employed individuals to save a maximum of 15 percent of their income up to a specified amount each year, and to deduct that amount from their yearly taxable income

what are the most frequently overlooked tax deductions?

state sales tax, reinvested dividends, out-of-pocket charitable contributions, student loan interest paid by parents, moving expenses to take a first job, military reservists' travel expenses, child care credit, estate tax on income in respect of a decendent, state tax paid the previous year, refinancing points, jury pay paid to employer

which of the following are tax-deferred investments?

tax-deferred annuities, Keogh, IRA, health savings plans

common itemized deductions

taxes, interest, contributions under 20% of AGI, casualty/theft losses, moving expenses, job-related/misc. expenses that exceed 2% of AGI

marginal tax rate

the rate used to calculate tax on the last (and next) dollar of taxable income

tax evasion

the use of illegal actions to reduce one's taxes

tax avoidance

the use of legitimate methods to reduce one's taxes (ex: delay receipt of income, accelerate deductions to save taxes)

how long should you keep tax records?

three years from the date you file your return; however, you may be responsible for back docs up to six years. Other records (like past returns & housing docs) should be kept indefinitely

how do you pay federal income taxes?

through payroll withholding or estimated tax payments

Which best describes the purpose of the alternative minimum tax?

to assure that people who receive tax breaks pay a fair share of taxes

Adjusted Gross Income (AGI)

total income before subtracting any deductions or expenses

average tax rate

total taxes paid divided by total income

adjustments to income

used as the basis for computing various deductions; includes contributions to IRAs, retirement plans, penalties for early savings withdrawal, and alimony payments

Reasons why it's beneficial to contribute as much as possible to a Keogh or 401k plan

1) the increased value of the investment accumulates on a tax-free basis until the funds are withdrawn 2) contributions reduce your adjusted gross income for computing current tax liability

types of income

1. earned income : salary bonuses, tips 2. Investment income: dividends, rent, interest 3. passive income: business activities that you are not active in, such as limited partnerships

Premature withdrawals from an Individual Retirement Account (IRA) are subject to a penalty of

10% of the withdrawn amount

value added tax (VAT)

A tax on increased value of the product at each stage of production and distribution rather than just at the point of sale.

dependent requirements

1) must not earn more than a set amount unless under the age of 19 or a full-time student under age 24 2) you must provide more than half of the dependent's support 3) the dependent must reside in your home or be a specified relative 4) must meet citizenship requirements

As "tax freedom day" came in mid-April, it means that the portion of the year people work to pay their taxes is represented by January 1 to

Mid-April