Chapter 3: Taxes in Your Financial Plan

Tax Credit versus Tax Deduction

$100 Tax Credit Reduces Your Taxes by $100 $100 Tax Deduction Amount of Tax Reduction is Based on your tax Bracket

Types of Tax

1. Taxes Purchase - Taxes on Property 2. Taxes on Property -Real estate property tax -Personal property tax 3. Taxes on Wealth -Federal estate tax -State inheritance tax 4. Taxes on Earnings -Income tax and Social Security

Tax Credits

Amount subtracted directly from the amount of taxes owed Examples: Earned income credits Foreign tax credits Child and dependent care credits Savers credit (formerly retirement tax credits) Adoption tax credits Education credits to offset college education expenses

Planning Your Tax Strategy

Start Planning for taxes...... -Know current tax laws as they affect you -Maintain complete and appropriate tax records -Make purchase and investment decisions that reduce your tax liability. Goal: Paying your fair share but still taking advantage of tax benefits.

AGI (Adjusted Gross Income)

Step 1: Determine AGI Taxable income Net income - income on which tax is computed Gross income minus allowable deductions

Main Components of Gross INcome

Earned Income -Usually includes wages, salary, commissions, fees, tips, and bonuses Investment income: - Money received in the form of dividends Passive income -Results from business activities in which you do not directly participate, such as a limited partnership Other income -Alimony, awards, lottery winnings, and prizes

Total Income is Affected by...

Exclusions -Amounts excluded from gross income -Also referred to as tax-exempt income; income not subject to federal income tax -Example - interest on most state and city bonds Tax-deferred income -Income that will be taxed at a later date, such as earnings from a traditional individual retirement account (IRA)

Calculate Taxable Income

Exemptions Exemptions > subtracted from AGI An exemption - a deduction for yourself, your spouse, or qualified dependents The amount of the

Completing the Federal Income Tax Return

Filing status and exemptions Income Adjustments to income Tax computation Tax credits Other taxes(such a Payments (total withholding and other payments Refund or amount you owes -Refunds can be directly deposited to your bank account -Payments may be directly debited from your bank account Your Signature - Most common filing error

Adjusted Gross Income (AGI)

Gross income reduced by certain adjustments, described below Adjustments to income -Reduce AGI -Contributions to a traditional IRA or Keogh -Alimony payments A tax shelter is an investments that provides immediate tax benefits

Calculable Taxable Income

Itemized Deductions Medical and dental expenses (>10% of AGI) Taxes Interest Contributions Casualty and theft loses Moving expenses Job - related and other miscellaneous expenses (>2% of AGI)

Alternative Minimum Tax (AMT)

Paid by taxpayers with high amounts of certain deductions and various types of income Designed to ensure that those who receive tax breaks

Taxable Income

Step 2. Computing Taxable Income Tax deduction - amount subtracted from adjusted gross income (AGI) to arrive at taxable income Standar Deduction Itemized Deductions

Calculating Taxes Owed

Step 3: Calculating taxes owed Tax table rates - marginal rates The tax rate paid on the last (or next) dollar of taxable income Example: After deductions and exemptions, a person in the 35% tax bracket pays 35 cents in taxes for every dollar of taxable income in that bracket

Making Tax Payments

Step 4: Making Tax Payments Payroll Withholding -Based on the number of expeditions and the expected deductions claimed Estimated Quarterly Payments -Estimated tax payments made throughout the year based on income made during the year and reported on Form 1099

Deadlines and Penalites

Step 5: Deadline

Average and Marginal Tax Rates

The average tax rate - the total tax due