Chapter 4- Personal Finance-Planning your Tax Strategies
Income included in gross income
Earned Income-Includes wages, salary, commissions, fees, tips or bonuses Investment income- (also known as portfolio income) is money from dividends, interest, or rent from investments Passive income is from business activities in which you do not actively participate, such as a limited partnership Other income includes alimony, awards, lottery winnings, and prizes
Types of Income Excluded from Gross Income
Exclusions are amounts NOT included in gross income; for example, a portion of foreign earned income -exclusions can also be tax-exempt income, which is income not subject to federal income tax, for example, interest earned on most state and city bonds
Illegal: Do not practice Tax Evasion
Illegally not paying all the taxes you owe, such as not reporting all income
Tax deferred
Income that will be taxed at a later date; for example, earnings on a individual retirement account (IRA)
Taxable income
net income, after deductions, on which income tax is computed
Tax credit
An amount subtracted directly from the amount of taxes owed $100 tax credit reduces your taxes by $100 $100 tax deduction reduces your taxes by $24 if you are in a 24% tax bracket
Adjusted Gross Income (AGI)
Gross income after certain reductions have been made. These reductions are called adjustments to income and include the following: -Contributions to an IRA or KEOGH retirement plan -Penalties for early withdrawal of savings -Alimony pmt -Tax-deferred retirement plans are a type of tax shelter
Average Tax Rate
Based on the total tax due divided by taxable income The average tax rate is less than a person's marginal tax rate Tax due / Income = %
Tax audit
detailed examination of your tax return by the IRS About 1% of all tax filers are audited
Tax-Exempt Investments
-Interest income form municipal bonds is not subject to federal income taxes -Interest on EE savings bonds is exempt from federal income tax if used for tuition
Legal: Practice Tax Avoidance
-Legitimate methods to reduce your tax obligation to your fair share but no more -Financial decisions related to purchasing, investing, and retirement planning are the most heavily affected by tax laws
Tax-Deferred Investments
-annuities -Retirement plans Section 529 savings plans for a child's education Capital gains are profits from sale of stocks, bonds, or real estate; taxes paid when sold
Calculating Taxable Income
1. Gross income 2. Less adjustments to income 3. Equals AGI 4. Less greater of Itemized or standard deduction 5. Equals taxable income
Must file?
Single - 12,000 MFJ - 24,000 MFS - 12,000 HOH - 18,000 Qualifying widow (2yrs) 24,000
Marginal Tax Rates
The last (and next) dollar of taxable income
Flexible spending accounts
allow you to reduce your taxable income when paying for medical expenses or child care costs
Tax deduction
an amount subtracted from AGI to arrive at taxable income -Subtract greater of standard deduction or itemized deduction Itemized medical (7.5% of AGI) Can only deduct $10,000 with all these together for taxes and state & local
Exemption
is a deduction for yourself, your spouse, and qualified dependents
