Chapter 4


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Chapter 4

  1. 1. Personal Finance: An Integrated Planning Approach Winger & Frasca Chapter 4 Taxes
  2. 2. Major Topics <ul><li>Determining Your Federal Income Tax </li></ul><ul><li>Other Aspects of the Federal Income Tax </li></ul><ul><li>Planning to Reduce Your Income Taxes </li></ul>
  3. 3. Figure 4.2 Federal Income Tax Formula Global Income Less Nontaxable Exclusions Gross Income { Adjustments to Gross Income { Adjusted Gross Income { Less personal and dependency deductions Less itemized or standard deductions Taxable Income {
  4. 4. Figure 4.2 Federal Income Tax Formula Taxable Income Taxes Before Credits and Other Taxes { Determine taxes based upon taxable income and family status Less tax credits plus other taxes { Taxes Before Credits and Other Taxes Tax Refund or Taxes Due Less taxes withheld and estimated taxes paid {
  5. 5. Gross Income <ul><li>Sources of income that are subject to the federal income tax </li></ul><ul><li>Primary Sources </li></ul><ul><li>wages and salaries alimony interest </li></ul><ul><li>capital gains dividends pensions </li></ul><ul><li>business income rentals royalties </li></ul><ul><li>partnerships </li></ul>
  6. 6. Adjusted Gross Income <ul><li>Gross income plus or minus </li></ul><ul><li>certain adjustments </li></ul><ul><li>Examples of possible exclusions </li></ul><ul><li>IRA contributions Moving expenses </li></ul><ul><li>Alimony paid </li></ul><ul><li>Self-employed health insurance </li></ul><ul><li>One-half of self-employment tax </li></ul>
  7. 7. Taxable Income equals <ul><li>Adjusted gross income less </li></ul><ul><ul><li>personal and dependency exemptions </li></ul></ul><ul><ul><li>personal deductible expenses </li></ul></ul>
  8. 8. Taxable Income <ul><li>Personal and dependency exemptions </li></ul><ul><ul><li>Each spouse on a joint return </li></ul></ul><ul><ul><li>Any of the taxpayer’s dependents </li></ul></ul><ul><ul><li>$2,900 for each dependent in 2001 </li></ul></ul>
  9. 9. Standard Deduction for 2001
  10. 10. Typical Itemized Deductions <ul><li>Medical expenses </li></ul><ul><ul><li>in excess of 7.5% of adjusted gross income </li></ul></ul><ul><li>State and local income taxes </li></ul><ul><li>Personal property taxes </li></ul>
  11. 11. Typical Itemized Deductions <ul><li>Interest on home mortgages (limitations) </li></ul><ul><li>Charitable contributions (limitations) </li></ul><ul><li>Casualty and theft losses (limitations) </li></ul><ul><li>Miscellaneous business related expenses </li></ul><ul><ul><li>in excess of 2% of adjusted gross income </li></ul></ul>
  12. 12. 2001 Tax Rate Schedule Single Taxpayers
  13. 13. 2001 Tax Rate Schedule Joint Taxpayers
  14. 14. <ul><li>A direct deduction against your tax liability </li></ul><ul><li>Examples of possible credit </li></ul><ul><ul><li>Credit for the elderly (include disability credit) </li></ul></ul><ul><ul><li>Earned income credit </li></ul></ul><ul><ul><li>Education tax credit </li></ul></ul><ul><ul><li>Child and dependent care expenses </li></ul></ul><ul><ul><li>Jobs credit </li></ul></ul>Tax Credits
  15. 15. Tax Rate Measures <ul><li>Average tax rate </li></ul><ul><ul><li>total tax liability divided by total income </li></ul></ul><ul><li>Marginal tax rate </li></ul><ul><ul><li>additional tax liability divided by additional income </li></ul></ul><ul><ul><li>the tax rate on an incremental dollar of income </li></ul></ul>
  16. 16. Capital Gains and Losses <ul><li>Gain or loss resulting from the sale of a capital asset </li></ul><ul><li>Capital asset is an asset held for pleasure or investment </li></ul><ul><li>Capital gains and losses receive special tax treatment </li></ul>
  17. 17. Taxes on Capital Gains <ul><li>The holding period will determine the tax rate on capital gains </li></ul><ul><ul><li>Gains or losses on a capital asset held less than one year are “short-term” </li></ul></ul><ul><ul><li>Gains or losses on a capital asset held one year or more are “long-term” </li></ul></ul><ul><li>Short-term gains or losses on financial assets are treated like changes to ordinary income </li></ul>
  18. 18. Taxes on Capital Gains <ul><li>The maximum tax rate for the gain on most long-term financial assets will depend upon your marginal tax rate </li></ul><ul><ul><li>The rate is 10% if you are in the 15% marginal tax bracket and 20% if you are in a higher tax bracket </li></ul></ul><ul><ul><li>This does not apply to collectibles which are taxed at a maximum rate of 28% </li></ul></ul>
  19. 19. Tax Treatment on Losses <ul><li>Capital losses on personal use assets are not deductible </li></ul><ul><li>Capital losses on financial assets may be deducted up to a $3,000 limit </li></ul><ul><ul><li>Losses not deducted in the current year may be carried forward to the next tax year </li></ul></ul>
  20. 20. Selling Your Home <ul><li>You can typically exclude from taxable income up to $250,000 ($500,000 if married) of the capital gain on the sale of your home </li></ul><ul><li>To get the full exclusion you must have owned the home for the last two years, and </li></ul><ul><li>used it as your main home for two recent years </li></ul>
  21. 21. Special Considerations for Students <ul><li>Scholarships and Fellowships </li></ul><ul><li>Employment related advantages </li></ul><ul><li>Education Tax Credits </li></ul><ul><li>Other Special Advantages </li></ul>
  22. 22. Scholarships and Fellowships <ul><li>Awards that cover purely educational expenses that lead to a degree are most likely not taxable </li></ul><ul><li>Payments for noneducational expenses are taxable </li></ul><ul><ul><li>subsistence allowances paid to ROTC students in advanced training is an exception </li></ul></ul>
  23. 23. Employment Related Advantages <ul><li>A qualified tuition reduction </li></ul><ul><ul><li>tuition reduction provided to employee or relative of employee </li></ul></ul>
  24. 24. Employment Related Advantages <ul><li>Qualifying educational expenses </li></ul><ul><ul><li>Must be required by employer to maintain or improve the skills needed in your current job </li></ul></ul><ul><ul><li>Cannot be used to prepare you for the minimal skills needed in your current position or prepare you for a new job </li></ul></ul><ul><ul><li>Itemized deduction that must exceed 2% of your adjusted gross income </li></ul></ul>
  25. 25. Employment Related Advantages <ul><li>Qualified educational assistance </li></ul><ul><ul><li>Includes educational expenses paid for by your employer </li></ul></ul><ul><ul><li>Your employer can tell you which expenses are qualified </li></ul></ul>
  26. 26. Education Tax Credits <ul><li>Hope Scholarship Credit </li></ul><ul><ul><li>For first two years of postsecondary education </li></ul></ul><ul><ul><li>Must be enrolled at least half-time in a degree program </li></ul></ul><ul><ul><li>Limit on maximum credit and phased out at higher incomes </li></ul></ul>
  27. 27. Education Tax Credits <ul><li>Lifetime Learning Credit </li></ul><ul><ul><li>May receive this credit in years you do not qualify for the Hope Scholarship Credit </li></ul></ul><ul><ul><li>Limit on maximum credit and phased out at higher incomes </li></ul></ul>
  28. 28. Other Special Tax Advantages <ul><li>Temporary College Deduction </li></ul><ul><li>Education IRA </li></ul><ul><li>State and Private Tuition Programs </li></ul><ul><li>Student Loan Interest </li></ul><ul><li>Education Savings Bonds </li></ul>
  29. 29. Plan to Reduce Your Taxes <ul><li>Invest where you receive tax-advantaged income </li></ul><ul><li>Take capital losses quickly </li></ul><ul><li>Split your income </li></ul><ul><li>Stagger income and expenses </li></ul><ul><li>Defer income to later years </li></ul>
  30. 30. Sources of Tax-Advantaged Income <ul><li>Municipal bonds </li></ul><ul><ul><li>tax exempt interest earned </li></ul></ul><ul><li>Home ownership </li></ul><ul><ul><li>tax exempt interest paid </li></ul></ul><ul><ul><li>capital gains exemption </li></ul></ul><ul><li>Real estate investments </li></ul><ul><ul><li>depreciation </li></ul></ul><ul><ul><li>loss deductions </li></ul></ul>
  31. 31. Defer Income to Later Years <ul><li>Pension plans </li></ul><ul><li>Tax-deferred annuities </li></ul><ul><li>US Treasury Series EE Bonds </li></ul>
  32. 32. Other Important Taxes <ul><li>Social Security Taxes </li></ul><ul><li>State and Local Taxes </li></ul><ul><ul><li>income taxes </li></ul></ul><ul><ul><li>property taxes </li></ul></ul><ul><ul><li>sales taxes </li></ul></ul><ul><li>Estate and Gift Taxes </li></ul><ul><ul><li>federal & state estate and gift taxes </li></ul></ul><ul><ul><li>state inheritance taxes </li></ul></ul>
  33. 33. Death Taxes <ul><li>A tax on property either transferred or received at death </li></ul><ul><li>Estate tax </li></ul><ul><ul><li>imposed on property of deceased before transfer </li></ul></ul>
  34. 34. Death Taxes <ul><li>Gift tax </li></ul><ul><ul><li>on gifts transferred during life </li></ul></ul><ul><li>Inheritance tax </li></ul><ul><ul><li>paid by beneficiary on property received </li></ul></ul>
  35. 35. Estate Tax Exemption
  36. 36. Federal Income Taxes <ul><li>Let goods that have appreciated in market value transfer at death </li></ul><ul><li>Don’t bequeath property that has depreciated in value </li></ul><ul><li>Be aware of how ownership can affect tax liabilities </li></ul>
  37. 37. Next Chapter 5 Cash Management