Exam 1

Which is better: A Deduction or A Credit?

Credit

A net worth statement for a previous year would show whether you were able to live within your means. T/F

False

A young person is likely to have more financial capital than human capital. T/F

False

If you choose the standard deduction, you can write off charitable donations. T/F

False

Which investment will earn more interest, one that compounds annually or one that compounds monthly?

Monthly

What is the first step of budgeting?

Setting Goals

SMART goals

Specific, Measurable, Attainable, Realistic, Timely

What is the difference between tax avoidance and tax evasion?

Tax avoidance - I do not want to pay more than I have to, so I am going to look through the tax code for any possible tax breaks. Notice that I am looking through the tax code for LEGAL ways to reduce my tax bill. Examples: Charitable deductions, education credits, etc. Tax Evasion - Purposely not paying the taxes you are legally obligated to pay. Examples: Not reporting cash income, falsifying deductions, etc. Tax evasion is illegal, tax avoidance is normal (to some degree).

Scarlett has a taxable income of $252,000. What is Jose's average tax rate given the following tax table?

Total tax = 19050*10%+(77400-19050)*12%+(165000-77400)*22%+(252000-165000)*24% = $49,059 Average Tax Rate = 49,059/252,000=19.4679%

Which of the following are possible deductions? * Medical Expenses * Credit Card Interest * Student Loan Interest *Home Mortgage Interest

* Medical Expenses *Home Mortgage Interest

Which of the following is an adjustment? * Gambling Losses * Contributions to your Checking * Credit Card Interest * Student Loan Interest

* Student Loan Interest

Financial Planning Process

1) Do it yourself 2) Have someone else do it 3) Have it done to you (Whether you can handle it yourself depends on your skills and your assets. Some people with lots of assets prefer to hire someone, even if they have the skills to plan for themselves, because it takes the pressure off of them and frees up time. Remember that time is valuable!)

Personal Finance knowledge and skills span over four main areas:

1. Resource Basis 2. Borrowing 3. Investing 4. Protection

Scarlett has a taxable income of $252,000. What is their marginal tax rate given the following tax table?

24% Marginal = tax owed on the next dollar.

Which is better? 1. I want to save more. 2. I want to save more for a car. 3. I want to save $100 a month for 2 years in order to have enough for a down-payment on a car.

3. I want to save $100 a month for 2 years in order to have enough for a down-payment on a car.

Match the following: Cash Flow Statement Net Worth Statement Income Annual Savings Mortgage Balance Utility Bills

Cash Flow Statement: Income, Annual Savings, Utility Bills Net Worth Statement: Mortgage Balance

If you choose the standard deduction, which of the following can you include on your return? •State Income Tax Deduction •Charitable Contributions Deduction •Mortgage Interest Deduction •Earned Income Tax Credit

Earned Income Tax Credit

Frederico currently has $650 in an account that earns 9% APR, compounded monthly. Assuming he doesn't withdraw any of the funds, how much will his balance be in 5 years?

FV = $1,017.6927

Assets on the balance sheet are valued at: •Fair market value. •Original purchase price. •Replacement cost. •Sentimental value.

Fair market value.

Receiving a $1,200 tax return is great because you can buy a lot with this money, right?

False! You want to receive $0. Anything above that is an interest free loan to the government.

Suppose you are faced with two investment opportunities: Alpha and Beta. Fund A provides an interest rate of 12.5 % per year, compounded annually. Fund B provides an annual interest rate of 12.5% compounded quarterly. Which investment provides more interest earned?

Fund B More frequent compounding = more money earned

Living Expenses Covered Ratio

How long can you survive without your income before running out of money.

Debt Ratio

How solvent you are.

Savings Ratio

How well are you saving for your goals.

Investment to Total Assets

How well you are building your wealth.

Deductions

If you take the STANDARD DEDUCTION, you CANNOT take itemized Deductions are different than adjustments mainly in that they go on your Schedule A. The big important thing here is that you can choose either the pre-set standard deduction, or itemized, whichever is higher. Most people will use the standard deduction unless they have a house with a mortgage. You will see that many of these have minimum amounts before you can deduct the expense based on AGI. Remember how important that number is!

Debt Service to Income

Measures if you have too much debt for your income.

Discretionary income refers to: •Pay received after employer withholding for taxes, insurance and union dues. •Money left over after necessities such as housing and food are paid for. •Projected dollar amounts you receive or spend in a period. •All of the above.

Money left over after necessities such as housing and food are paid for. Discretionary money is your "fun money." Versus disposable income (income after tax) = net income

If the annual interest rate is 5%, how long will it take to double your investment?

N = 14.2067 years

You have a credit card balance of $3,506.74. You quit using the card and make monthly payments of $100. Assuming your annual interest rate is 24%, how long will it take you to pay off the balance?

N = 61.0261 months => 5.0855 years

Is Tax Avoidance Illegal?

No! (Tax EVASION is!)

Matt needs to start paying back his student loan. The amount he owes is $12,045.60 with an APR of 6.02%. Assuming he will take 9 years, how much will his monthly payment be?

PMT = $ -144.7356

Betsy currently has $2,000 in an account with an annual rate of return of 5.3%. She wants to have $5000 for a trip to South America when she graduates in 5 years. How much will she have to save each month to afford her trip?

PMT = $ -34.9436

Disposable income refers to: •Pay received after employer withholding for taxes, insurance and union dues. •Money left over after necessities such as housing and food are paid for. •Projected dollar amounts to receive or spend in a period. All of the above.

Pay received after employer withholding for taxes, insurance and union dues. Also known as "take-home pay."

Tax Liability Formula

We will look at specifics later, but if you subtract adjustments and exclusions, you get to your adjusted gross income, or AGI. If you are following along on a 1040, you are now at the bottom of the first page! From your AGI you subtract either the standard deduction or itemized deductions (also known as Schedule A), and you exemptions which is a fixed amount per person on your return. This gets you to your taxable income. You use your taxable income to calculate your total taxes owed. Then you subtract any credits you qualify for to get to your tax liability. Now, this is not shown on the slide, but if you are completing your 1040, you would then subtract any pre-payments (such as withholdings) and get to the total amount refunded or owed. Why do I make such a big deal about the order here? AGI is an extremely important number for many reasons that we will not cover, but it is important for you to know what comes before and after you calculate the taxes you owe. After you calculate your taxes, the credits reduce your tax liability dollar for dollar. One dollar in credits is one dollar saved in taxes. Before you calculate taxes, one dollar of savings gets multiplied by your tax rate to get you to the amount you saved, so if you are in the 25% marginal tax bracket, one dollar in adjustments or deductions will only save you $0.25 on your tax bill. This is VERY important to keep in mind when we discuss tax write-offs.

Budget

• Future • How Will You Meet Your Goals?

Types of Resources

• Human Capital (knowledge and skills that you bring to the table Build human capital through college or trade school. Get certifications. Become proficient at software.) • Financial Literacy (is a form of human capital that is specific to personal finance. It consists of your knowledge and ability to apply knowledge related to personal finance. (NOTE: it will NOT help you navigate the economy!)) • Durable Goods (the stuff you buy with your money! You get happiness from these goods through their use.) • Financial Capital (earnings. You build your human capital in order to increase your financial capital. You financial capital gives you happiness indirectly through durable goods or things like services or vacations)

Filing Taxes (Form 1040)

• Income • Exclusions/Adjustments • Deductions • Credits Filing taxes may seem overwhelming, but it is a fairly simple process when you look at the big picture. You start by figuring out your income, then your exclusions and adjustments, followed by deductions, exemptions, and credits. These items may not apply to everyone, but you want to check to see if they apply to you.

Income Statement

• Past • Cash Flow Over A Period of Time • Can You Afford Your Spending? • Shows how well you are managing your money. • If you are spending more or close to what you are earning you could be in trouble • Ask yourself "has cash moved" or "is there a cash-flow?" If there is not then you are more than likely dealing with the balance sheet. (If you miss a payment then the bill moves from the statement of cash flow to the balance sheet)

Balance Sheet

• Present • Snapshot at One Point in Time • Net Worth - solvent vs. Insolvent • It cannot tell you about cash flows or how you are doing now. It shows you what you own and owe. • Total Assets= Total Liabilities + New Worth

Time for goals

• Short-term • Intermediate-term • Long-term

Exclusions/Adjustments

• Student Loan Interest • HSA Deduction • Moving Expenses (very limited) • IRA Deduction • Tuition and Fees (Limited) These are items at the bottom of page one of the 1040. These are not very common, but can include student loan interest, HSA, IRA,, some moving expenses, and possibly tuition and fees. Do not get confused here when it says "deduction" after several of the items, these are not deductions. These are exclusions because you are removing them from total income to get to your adjusted income. Don't get hung up on this, just know that there is a difference. I said that these are not common, which might be confusing as you probably know many people who get tuition and fees as a write-off. There are actually a couple of credits for tuition and fees that are a lot better because they are dollar for dollar!

Which of the following statements is correct? •Gross income is always less than adjusted gross income •Adjusted gross income is always greater than taxable income •Adjusted gross income is always greater than tax deductions •Gross income is always greater than tax exclusions and adjustments

•Adjusted gross income is always greater than taxable income

What is the FV of a Loan???

$0

What is the optimal tax refund?

$0

Jason and Larissa would like to have a monthly living expense covered ratio (basic liquidity ratio) of 3. They currently have $2,800 in their account and their annual expenses are $54,000. How much more do they need in their account to reach their goal?

$10,700

Which of the following is correct regarding sales tax? * All States impose tax on purchases * Excise taxes are part of sales taxes * Lower income people pay higher percentages of their income on sales taxes than higher income people *All of these

* Lower income people pay higher percentages of their income on sales taxes than higher income people

Life Cycle Chart

•Dependency •Production •Post-Production (Build your human capital over the dependency period and at the beginning of the production period in order to boost your financial capital later in the production period. This can lead to a higher consumption stream in the post-production period, and can help to make you more financially sound in retirement. Here your only option to get higher consumption is to borrow! But that's usually not a good idea! When you are young you mostly only have human capital because you haven't had a chance to earn financial capital but you also have lots of time on your side. That is the time to invest in yourself so you can reach high levels of financial capital! As you age you will begin losing your human capital. You will need your financial capital to get you through.)

W4

•Estimate of Tax Liability •Goal = Withhold Exactly Correct $$$ •Over-withholding - Information for your company to withhold an estimate of the taxes you will owe from your job. Be careful - your employer does not know your situation, so you need to estimate your own bill and may need to have more withheld (which you can fill out on the W4). If your employer withholds too little, you will owe taxes. If your employer withholds too much, you will get a refund. Is this bad? Yes! This is an interest-free loan you gave the government! You let them use your money for free!

Common Deductions (Schedule A - Itemized Deductions)

•Medical (in excess of 10% of AGI) •State and Local Sales or Income Tax •Real Estate Taxes •Personal Property Taxes •Mortgage Interest (and HELOC) •Investment Interest •Charitable Donations (To QUALIFIED Organizations) •Casualty and Theft Losses (in Excess of 10% of AGI) •Other (In Excess of 2% of AGI) •Some Business Expenses •Tax Prep Fees •Safe Deposit Box Fees •Some Investment Expenses •Gambling Losses (Up To Amount of Winnings)