Personal Finance Chapter 4: Planning Your Tax Strategy

What factors affect your choice of a 1040 form?

Depends on your type of income, the amount of your income, the number of deductions, and the complexity of your tax situation.

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 s deceased person.

How should you consider taxes in your financial planning?

- Know the current tax laws and regulations that affect you. - Maintain complete and appropriate tax records. - Make purchasing and investment decisions that can reduce your tax liability.

What are the main sources available to help people prepare their taxes?

- Publications - Recorded Messages - Phone Hot Line - Walk-in Service - Interactive Tax Assistant - DVD

What common tax-saving methods are available to most individuals and households?

- Time the receipt of income and payment of taxable expenses in relation to your current and future tax rate. - Take advantage of tax credits for which you qualify. -Maximize contributions to tax-deferred retirement programs. - Consider tax-exempt investments, such as municipal bonds. - Defer capital gains and accelerate capital losses. - Take advantage of the tax benefits of owning your own business. - Plan purchases, such as a house or health care, with tax implications in mind. - Search out all possible itemized deductions.

What appeal process do taxpayers have if they disagree with an audit decision of the IRS?

-Present tax records and receipts in a logical, calm, and confident manner.

Exemption

A deduction from adjusted gross income 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.

Exculsion

An amount not included in gross income.

Tax Credit

An amount subtracted directly from the amount of taxes owned.

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.

In what ways does your filing status affect preparation of your federal income tax return?

Filing status affects the amount of deductions as well as taxable income.

Adjusted Gross Income

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

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.

What is the difference between your marginal tax rate and your average tax rate?

Marginal will always be higher than average.

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.

Capital Gains

Profits from the sale of a capital asset such as stocks, bonds, or real estate.

What types of taxes do people frequently overlook when making financial decisions?

Sales, Excise, Property, Estate, Inheritance, and state and local income taxes.

What information is needed to compute taxable income?

Subtract adjustments to income, deductions, and exemptions from gross income.

How does a tax credit affect the amount owed for federal income tax?

Tax Credit reduces the amount owed for federal income tax.

How does tax avoidance differ from tax evasion?

Tax avoidance is using methods to reduce one's taxes, whereas tax evasion is using illegal actions to reduce one's taxes.

How does tax-exempt income differ from tax-deferred income?

Tax-Exempt Income is income that is not subject to tax, whereas Tax-Deferred Income is income that will be taxed at a later date.

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.

Tax Evasion

The use of illegal actions to reduce one's taxes.

Tax avoidance

The use of legitimate methods to reduce one's taxes.

Average Tax Rate

Total tax due dividend by taxable income.

What actions can reduce the chances of an IRS audit?

Using a tax preparation service can help to reduce the chances of an audit.

When would you use the standard deduction instead of itemized deductions?

When you have not had large medical, real estate, mortgage interest, charitable contribution, casualty loss, or certain work-related expenses.