Chapter 4: Planning Your Tax Strategy

Subtract Adjustments From Gross Income (AGI)

- Contributions To A Traditional IRA

Subtract Standard Deduction Or Itemized Deductions And Exemptions (Taxable Income)

- Exemption - Standard Deduction

Subtract Tax Credits And Add Other Taxes Due (Total Tax)

- Lifetime Learning Credit - Self-Employment Taxes

IRS Services

1. Publications 2. Recorded Messages 3. Phone Hot Line 4. Walk-In Service 5. Interactive Tax Assistant 6. DVD

What results in a dollar-for-dollar reduction in the amount of taxes owed?

Hope Scholarship and Lifetime Learning tax credits

Tax Credits VS. Tax Deductions

$100 Tax Credit - Will reduce you taxed by $100 $100 Tax Deduction - Will reduce your taxable income by $100 (depending on your tax bracket) The ATM was originally designed to prevent those with high incomes from using special tax breaks to pay little in taxes. Some of these special tax breaks that can result in a person paying the AMT include high levels of deductions for state and local taxes, interest on second mortgages, medical expenses, and other deductions. Other items that can trigger the AMT are incentive stock option, long-term capital gains, and tax-exempt interest.

If you get a large tax refund, it is wise to:

- Pay off credit cards - Change your withholding amount - Save it for retirement

Calculate Tax Based On Tax Tables (Tax)

- Tax Due

Types of Tax Services

- Tax services range from local, one-person operations to national firms with thousands of offices, such as H&R Block. - Enrolled Agents - government approved tax experts - prepare returns and provide tax advice. - Many accountants offer tax assistance along with other business services. A certified public accountant (CPA) with special training in taxes can help with tax planning and the preparation of your annual tax return. - Attorneys usually do not complete tax returns; however, you can use an attorney's services when you are involved in a tax-related transaction or when you have a difference of opinion with the IRS.

Calculate Gross Income (Total Income)

- Wages - Profits From Business - Interest On Savings Account - Dividends On Stock

Who Must File?

1. Single - Never-married, divorced, or legally separated individuals with no dependents. 2. Married, Filing Joint Return - Combines the income of a husband and a wife. 3. Married, Filing Separate Returns - Each spouse is responsible for his or her own tax. Under certain conditions, a married couple can benefit from this filing status. 4. Head of Household - An unmarried individual or a surviving spouse who maintains a household (paying for more than half of the costs) for a child or a dependent relative. 5. Qualifying Widow or Widower - An individual whose spouse died within the past 2 years and who has a dependent; this status is limited to 2 years after the death of the spouse.

Federal Income Tax Return - Form 1040

1. Your marriage and household situation will affect your taxable income and tax rate. 2. Your earnings and other sources of income will be reported in this section. 3. AGI results from certain deduction and will be used as a basis for computing other deductions. 4. In this section, you subtract your itemized deductions or the standard deduction and exemptions to obtain taxable income; your tax is based on the tax tables or schedule. 5. Tax credits are deducted at this point. 6. Any additional taxes owed are added at this point. 7. The federal income tax you have had withheld or payments you have made are recorded here. 8. Your total tax is compared to your total payments to determine your refund or amount due. 9. Don't forget to sign the form and your check!!

Estate Tax

A tax imposed on the value of a person's property at the time of his or her death.

Inheritance Tax

A tax levied on the value of property bequeathed by a deceased person.

Computing Taxable Income

AGI - Standard deductions and exemptions = Taxable Income OR AGI - Itemized deductions and exemptions = Taxable Income

Withholding

After the end of the year, you will receive a W-2 form, which reports your annual earnings and the amounts that have been deducted for federal income tax, Social Security, and, if applicable, state income tax. A copy of the W-2 form is filed with your tax return to document your earning and the amount you have paid in taxes. - Have an amount from each paycheck deposited in a savings or investment account. - Use the funds to reduce high-interest credit card debt. - Make contributions to retirement and college-savings plans.

Exclusion

An amount not included in gross income.

Tax Credit

An amount subtracted directly from the amount of taxes owed.

Tax Deduction

An amount subtracted from adjusted gross income to arrive at taxable income.

Tax Shelter

An investment that provides immediate tax benefits and a reasonable expectation of a future financial return.

Itemized Deductions

Expenses that can be deducted from adjusted gross income, such as medical expenses, real estate property taxes, home mortgage interest, charitable contributions, casualty losses, and certain work-related expenses.

Taxes on Wealth

For 2013, individuals are allowed to give money or items valued at $14,000 or less in a year to a person without being a subject to taxes. Gift amounts greater than $14,000 are subject to federal tax.

Adjusted Gross Income (AGI)

Gross income reduced by certain adjustments, such as contributions to an individual retirement account (IRA) and alimony payments.

A Tax Record-keeping System

Income Records: - W-2 forms reporting salary, wages, and taxes withheld. - W-2P forms reporting pension income. - 1099 forms reporting interest, dividends, and capital gains and losses from savings and investments. - 1099 forms for self-employment income, royalty income, unemployment, state refunds, and lump-sum payments from pension or retirement plans

Passive Income

Income resulting from business activities in which you do not actively participate.

Tax-Exempt Income

Income that is not subject to tax.

Tax-Deferred Income

Income that will be taxed at a later date.

If 435,000 people each receive an average refund of $2,400, based on an interest rate of 3 percent, what would be the lost annual income from savings on those refunds? Assume the savings could have been invested for the entire year.

Lost annual income = 435,000 × $2,400 × 0.03 = $31,320,000

Tax Credits

Low-income workers can benefit from the earned-income credit (EIC). Other recent tax credits have included: - Foreign tax credit to avoid double taxation on income taxes paid to another country. - Child and dependent care expense credit to cover qualifying expenses to pay for someone else to care for your child under age 13 or dependent who could not care for themselves. - Retirement savings tax credit to encourage investment contributions to individual and employer-sponsored retirement plans by low and middle-income taxpayers. - Adoption tax credit to cover qualifying expenses when adopting a child. - American Opportunity and Lifetime Learning tax credit to help offset college education expenses. - Mortgage interest tax credit for low-income, first-time home buyers. - Energy-savings tax credit when purchasing various energy-efficient products or renewable home energy systems. - Elderly and disabled tax credit assists low-income people age 65 or older, and those under age 65 retired with a permanent disability and taxable disability income.

Earned Income

Money received for personal effort, such as wages, salary, commission, fees, tips or bonuses.

Investment Income

Money received in the form of dividends, interest, or rent from investments. Also called portfolio income.

Is It Taxable Income? Is It Deductible?

Records such as copies of past tax returns and home ownership documents should be kept indefinitely.

Tax-deferred income would:

Reduce your current taxes.

Computing Taxable Income and Your Tax Liability

Step 1: Determining Adjust Gross Income Step 2: Computing Taxable Income Step 3: Calculating Taxes Owed

Planning Your Personal Finances

1. Taxes - State and local income tax, real estate property tax, and state or local personal property tax. 2. Interest - Mortgage interest, home equity loan interest, and investment interest expense up to an amount equal to investment income. 3. Contributions - Giving cash or property to a qualified charitable organization. 4. Casualty & Theft Losses - Financial losses resulting from natural disasters, accidents, or unlawful acts. 5. Moving Expenses - When a change in residence is associated with a new job that is at least 50 miles farther from your former home than your old main job location. 6. Job-Related & Other Miscellaneous Expenses - Such as unreimbursed job travel, union dues, required continuing education, work clothes or uniforms, investment expenses, tax preparation fees, and safe deposit box rental (for storing investment documents). The total of these expenses must exceed 2% of AGI to qualify as a deduction.

Income from which of the following investment would be considered tax-exempt?

10-Year Municipal Bond

Exemption

A deduction from AGI for yourself, your spouse, and qualified dependents.

Standard Deduction

A set amount on which no taxes are paid.

Excise Tax

A tax imposed on specific goods and services, such as gasoline, cigarettes, alcoholic beverages, tires and air travel.

A common mistake that taxpayers make when being audited is?

Talking too much.

Calculating Taxes Owed

Tax based on tax tables or tax schedules - Tax credits + Other taxes = Total tax due

Taxes on Earnings

The 2 main taxes on wages and salaries are Social Security and income taxes. Throughout the year, your employer will withhold income tax payments from your paycheck, or you may be required to make estimated tax payments if you own your own business. The Federal Insurance Contributions Act (FICA) created the Social Security tax to fund the old-age, survivors, and disability insurance portion of the Social Security system and the hospital insurance portion (Medicare).

Taxable Income

The net amount of income, after allowable deductions, on which income tax is computed.

Marginal Tax Rate

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

Average Tax Rate

Total tax due divided by taxable income.

Taxes and Financial Planning

Understanding tax rules and regulations can help you reduce your tax liability. To help you cope with these taxes, common goals related to tax planning include: - Knowing the current tax laws and regulations that affect you. - Maintaining complete and appropriate tax records. - Making purchase and investment decisions that can reduce your tax liability. Most people pay taxes in four major categories: 1. Taxes on purchases. 2. Taxes on property. 3. Taxes on wealth. 4. Taxes on earnings.

Making Tax Payments

You will make your payment of income taxes to the federal government in one of two ways: 1. Through payroll withholding. 2. Through estimated tax payments.