Chapter 3: Taxes in Your Financial Plan

some taxpayers view annual tax refund as

"forced savings" this is giving the government a free loan. A payroll deduction plan for savings could serve the same purpose while also earning interest on your funds

many taxpayers view an annual tax refund as a

"windfall", extra money they count on each year. These taxpayers are forgetting hte opportunity cost of withholding excessive amounts

tax deduction

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

The Roth IRA annual contribution limit

$5,500. The earnings on the account are tax free after 5 years. The funds from the Roth IRA may be withdrawn before the age of 59.5 if the account owner is disabled or for the purchase of a first home ($10,000 max.) Limited to people with an adjusted gross income under a certain amount

IRA contribution limit as of 2017

$5,500. Workers age 50 and over were allowed to contribute up to $6,500 as a "catch up" to make up for lost time saving for retirement

recent tax changes

-advanced tax credit -penalties for those who do not have health insurance -employers now allow employees with health care flexible spending accounts -streamlined options

taxes on wealth

-estate tax: the value of a person's property at the time of death -federal tax based on the fair market value of the deceased person's investments, property, bank accounts, and other taxes - money and property passed down may be subject to a state tax

tax situations that can result in a person paying the AMT includes

-high levels of deductions for state and local taxes -interest on second mortgages -medical expenses -other deduction -income items that can trigger the AMT are incentive stock options, long term capital gains, and tax exempt interest

taxes on property

-major source of revenue for the local government -based on the value of land and buildings -personal property taxes are on: automobiles, boats, furniture, farm equipment, and livestock

steps to pay federal income tax

1. determine adjusted gross income 2. compute taxable income 3. calculate taxes owed 4. making tax payments 5. deadlines and penalties

a person in the 35% tax bracket pays what in taxes for the next dollar of taxable income in that bracket

35 cents

itemized deductions must be reported on what form

Form 1040 Schedule A form

enrolled agents

Government approved tax experts. They prepare returns and provide tax advice.

retirement plans

IRA, Keogh, or 401K plans (example of tax deferred investments)

Why did the FICA create social security?

to fund the old age, survivors, and disability insurance portion of the social security system and the hospital insurance portion (Medicare)

What are the two main taxes on wages and salaries?

Social Security and income taxes

other types of income subject to federal income tax include:

alimony, awards, lottery winnings, credit card sign up bonuses, and prizes

total income is also affected by exclusions (tax exempt income) which are

amounts not included in gross income ex: the foreign income exclusion allows US citizens working and living in another country to exclude a certain portion of their income from federal income taxes ex: interest earned on most state and city bonds is exempt from federal income tax

earned income

Usually includes wages, salary, commissions, fees, tips, and bonuses

difference between standard deduction and itemized deductions

a standard deduction is a set amount on which no taxes are paid while itemized deductions are expenses a taxpayer is allowed to deduct from adjusted gross income

a tax credit differs from a deduction in that

a tax credit has a full dollar effect in lowering taxes, whereas a deduction reduces the taxable income on which the tax liability is computed

excise tax

a tax imposed on specific goods and services such as gasoline, cigarettes, alcohol, tires, and air travel

inheritance tax

a tax levied on the value of property bequeathed (passed on) by a deceased person

tax credit

an amount subtracted directly from the amount of taxes owed

what is form 1040?

an expanded version of Form 1040A that includes sections for all types of income. You are required to use this form if your income is over $100,000 or if you can be claimed as a dependent on your parents' return and you had interest or dividends over a set limit

filing status: qualifying widow

an individual whose spouse died within the past two years and who has a dependent; this status is limited to two years after the death of the spouse

filing status: head of household

an unmarried individual or a surviving spouse who maintains a household for a child or a dependent relative

what date are most people required to file a federal income tax

april 15

Tax planners advice people to contribute how much to their retirment?

as much as possible because the increased value of the investment accumulates on a tax free basis until the funds are withdrawn and contributions reduce your adjusted gross income for computing current tax liability

401K plan

authorizes the retirement plan to be sponsored by an employer. This plan allows you to contribute to a greater tax deferred amount than you can contribute to an IRA. Workers age 50 and over may be allowed to contribute an additional $6,000 if their employer allows. Most companies set a limit on your contribution such as 15% of your salary

streamlined options for advanced tax credits

available for the home office deduction for small businesses

health savings accounts

available with high deductible health insurance polices, may be utilized for current heath care expenses or for retirement in future years (example of tax deferred investments)

average tax rate

based on the total tax due divided by taxable income. Except for taxpayers in the 10% bracket, this rate is less than a person's marginal tax rate ex: a person with taxable income of $50,000 and a total tax bill of $8240 would have an average tax rate of 16.5% (8,240/50,000)

how does the process of determining your adjusted gross income start?

by determining your taxable income

filing status: married, filing joint return

combines the spouses' incomes

examples of adjusted gross income

contributions to an individual retirement account (IRA) or a Keogh retirement plan, penalties for early withdrawal of saving, and alimony payments

exemptions

deduction from adjusted gross income for yourself, spouse and qualified dependents

Alternative minimum tax (AMT)

designed to ensure that those who receive tax breaks also pay their fair share of taxes

filing status: married, filling separate return

each spouse is responsible for their own tax; under certain conditions, a married couple can benefit from this filing status

tax credit for low income workers

earned income credit (EIC) for working parents with taxable income under a certain amount.

the three main components of total income are:

earned income, investment income, and passive income

investment income (portfolio income)

earnings from dividends, interest, and rent from investments

What do you pay federal income taxes through?

either payroll withholding or estimated tax payments

recent tax credits include

foreign tax credit saver's credit adoption tax credit education credits child tax credit

how long should you keep tax records?

generally three years from the date you file your return. However, you may be held responsible for providing back documentation up to 6 years. Records such as past tax returns and housing documents should be kept indefinitely

Adjusted Gross Income (AGI) (adjustments to income)

gross income after certain reductions have been made

you are required to maintain records to document tax deductions such as a:

home filing system

What is reported on 1099 Form

income from savings, investments, independent contracting, royalties, and pension payments people who recieve such income may be required to make tax payments during the year (April 15, June 15, September 15, and January 15 as the last payment for the previous year)

tax deferred income

income that will be taxed at a later date

amount individuals are allowed to give without being subject to tax

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

additional medicare surtax of .9 percent on

individuals who make over $200,000 or $250,000 jointly

tax shelters

investments that provide immediate tax benefits and a reasonable expectation of a future financial return

tax deferred annuities

issued by insurance companies

municipal bonds interest

issued by state and local governments, and other tax exempt investments is not subject to federal income tax. Although municipal bonds have lower interest rates than other investments, the tax equivalent income may be higher

tax planning starts with

knowing current tax laws, maintaining complete and appropriate tax records then making purchase and investment decisions that can reduce your tax liability. Your primary goal should be to pay your fair share of taxes while taking advantage of appropriate tax benefits

tax deferred investments

less beneficial than tax exempt investments. They give you the advantage of paying taxes in the future rather than now ex: tax differed annuities

tax services range

local, one person operations to national firms with thousands of offices, such as H&R Block

The 10, 15, 25, 27, 33, 35, and 39,6 percent rates are referred to as

marginal tax rates

separate tax rate schedule also exists for

married persons who file separate income tax returns

common itemized deductions

medical and dental expenses, taxes, interest, contributions, casualty and theft losses, moving expenses, job related and other miscellaneous expenses

When and what is Tax Freedom Day?

mid April and the time that elapsed from January 1st until mid April represents the portion of the year people work to pay their taxes

field audit

most complex audit; an IRS agent visits your home, business, or office of your accountant to have access to your records.

qualifications of a dependent

must not earn more than a set amount unless they are under age 19 or a full time student under the age of 24; you must provide more than half of the dependent's support and the dependent must reside in your home or be a specified relative and must meet certain citizenship requirements

the tax code

myriad of changes. In the past several years there have been debates over what types of tax reform would stimulate economic growth. Congress frequently passes legislation that changes the tax code. These changes require that you regularly determine how to best take advantage of the tax laws for personal financial planning

filing status: single

never married, divorced, or legally separated individuals with no dependents

advanced tax credits

offers someone buying insurance through the heath care exchanges an opportunity to reduce the premiums they pay. If they do not get the full credit when they pay the premium, the difference will be available as a refundable tax credit at tax time

place of residence

owning a home is one of the best tax shelters. Both real estate property taxes and interest on the mortgage is deductible and thus reduces your taxable income

canceled checks and receipts serve as proof of

payment for deductions such as charitable contributions, medical expenses, and business related expenses.

flat tax

requires all taxpayers, regardless of income level and type, pay the smae percentage. This would be an increase in overall tax for many people

the 5 filing status categories

single married, filing joint return married, filing seperate returns head of household qualifying widow

wage cap for social security and medicare

social security: $127,200 medicare: none

What is social security and medicare tax percentage for most people?

social security: 6.2% medicare: 1.45% total: 7.65% self employed people pay double

most frequently overlooked tax deductions

state sales taxes 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 decedent state tax paid the previous year refinancing points jury pay paid to employer

accountants offer what kind of assistance?

tax assistance along with other business services. A certified public accountant with special training in taxes can help with tax planning and the preparation of your annual tax return

tax owed may be reduced by a

tax credit

difference between tax exempt income and tax deferred income

tax exempt income is income that is not subject to tax while tax deferred income is income that will be taxed at a later date

What are the four major tax categories?

taxes on purchases, property, wealth, and earnings

taxable income

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

correspondence audit

the simplest and most frequent type of audit. This mail requires you to clarify or document minor questions

tax evasion

the use of illegal actions to reduce one's taxes

tax avoidance

the use of legitimate methods to reduce one's taxes

attorney services for tax returns

they do not complete tax returns; 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

what is form 4868 for?

to obtain an automatic six month extension on your 1040 form and other documents if you're unable to file on time. This does not delay your payment liability you must submit the estimated amount along with form 4868 by April 15. Failure to file on time can result in a penalty for being just one day late. Underpayment due to negligence or fraud can result in penalties of 50 to 74 percent

tax rates

use your taxable income in conjunction with the appropriate tax table or tax schedule

marginal taxrates

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

penalties for those who do not have health insurance

will be levied through a program with the IRS. Taxpayers will soon have to provide proof of health insurance with their tax return to avoid the penalty

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. Both types of payments are only estimates; you may need to pay an additional amount or you may get a tax refund

value added tax (VAT)

would add a tax to a product for each stage in the manufacturing process

the office audit

you are required to visit an IRS office and clarify some aspect of your tax return

What does a W-2 form report

your annual earnings and the amounts deducted for taxes

basis for computing the amount of tax owed

your taxable income