Planning Your Tax Strategy Personal Finance C HAPTER   4 Kapoor  Dlabay  Hughes 7e 4-1
Taxes and Financial Planning <ul><li>About one-third of each dollar you earn goes to pay taxes. </li></ul><ul><li>An effec...
Taxes and Financial Planning  (continued) <ul><li>To help you cope with the many types of taxes you should... </li></ul><u...
Four Types of Taxes <ul><li>Taxes on purchases. </li></ul><ul><ul><li>Sales tax & excise tax. </li></ul></ul><ul><li>Taxes...
What Tax Records to Keep <ul><li>Current tax forms and instruction booklets. </li></ul><ul><li>Social security numbers. </...
Computing Your Tax Liability <ul><li>Step 1: Determining adjusted gross income. </li></ul><ul><ul><li>First identify taxab...
Computing Your Tax Liability   (continued)   <ul><ul><li>Total income is affected by exclusions. </li></ul></ul><ul><ul><u...
Computing Your Tax Liability   (continued) <ul><ul><li>Adjusted gross income is is gross income after certain reductions h...
Computing Your Tax Liability   (continued) <ul><li>Step 2: Computing Taxable Income. </li></ul><ul><ul><li>A tax deduction...
Computing Your Tax Liability   (continued) <ul><ul><li>Next subtract exemptions from AGI. </li></ul></ul><ul><ul><ul><li>A...
Computing Your Tax Liability   (continued) <ul><li>Step 3: Calculating taxes owed. </li></ul><ul><ul><li>The percent rates...
Computing Your Tax Liability   (continued) <ul><li>A person’s  average  tax rate is based on the total tax due divided by ...
Tax Credit versus Tax Deduction 4-13 $100 Tax Credit Reduces Your Taxes by $100 $100 Tax Deduction Amount Your Taxes are R...
W-2 Form <ul><li>Determine tax withheld </li></ul>Making Tax Payments - Withholding 4-14
Filing Your Federal Income Tax Return <ul><li>There are five filing status categories. </li></ul><ul><ul><li>Single or leg...
Which Tax Form Should You Use? <ul><li>This is the form for those with the least complicated situations.  Quick and easy t...
Decide Which Tax Form to Use <ul><li>Taxable income less than $50,000. </li></ul><ul><li>Adjustments to income are allowed...
Completing Your Federal Income Tax Return <ul><li>In summary the steps to completing your return include: </li></ul><ul><u...
Completing Your  Federal Income Tax Return <ul><ul><li>Determine if you are due a refund or owe tax. </li></ul></ul><ul><u...
Tax Information Sources <ul><li>The IRS has methods of assistance. </li></ul><ul><ul><li>Publications and forms 1-800-TAX-...
Tax Information Sources <ul><li>Electronic filing.  </li></ul><ul><ul><li>Currently over 45 million people file their retu...
Tax Information Sources <ul><li>Tax preparation services. </li></ul><ul><ul><li>Range from a one-person office to large fi...
What if Your Return is Audited? <ul><li>About 0.6% of all returns are audited. </li></ul><ul><li>If you claim large or unu...
Tax-Planning Strategies <ul><li>Practice tax avoidance. </li></ul><ul><ul><li>Legitimate methods to reduce your tax obliga...
Tax-Planning Strategies <ul><li>To minimize taxes owed... </li></ul><ul><ul><li>If you expect to have the same or a lower ...
Tax-Planning Strategies <ul><li>Owning a home is one of the best tax shelters because you can deduct mortgage loan interes...
Tax-Planning Strategies  (continued) <ul><li>Long -term capital gains taxed at a lower rate. </li></ul><ul><ul><li>Held mo...
Tax-Planning Strategies  (continued) <ul><li>Long-term capital gains on the sale of a home are excluded from taxes up to a...
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Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 2004 ...

  1. 1. Planning Your Tax Strategy Personal Finance C HAPTER 4 Kapoor Dlabay Hughes 7e 4-1
  2. 2. Taxes and Financial Planning <ul><li>About one-third of each dollar you earn goes to pay taxes. </li></ul><ul><li>An effective tax strategy is vital for successful financial planning. </li></ul><ul><li>Understanding tax rules and regulations can help you reduce your tax liability. </li></ul>4-2
  3. 3. Taxes and Financial Planning (continued) <ul><li>To help you cope with the many types of taxes you should... </li></ul><ul><ul><li>Know current tax laws as they affect you. </li></ul></ul><ul><ul><li>Maintain complete and appropriate tax records. </li></ul></ul><ul><ul><li>Make purchase and investment decisions that reduce your tax liability. </li></ul></ul><ul><li>Your tax planning should be targeted toward paying your fair share but still taking advantage of tax benefits. </li></ul>4-3
  4. 4. Four Types of Taxes <ul><li>Taxes on purchases. </li></ul><ul><ul><li>Sales tax & excise tax. </li></ul></ul><ul><li>Taxes on property. </li></ul><ul><ul><li>Real estate property tax. </li></ul></ul><ul><ul><li>Personal property tax. </li></ul></ul><ul><li>Taxes on wealth. </li></ul><ul><ul><li>Federal estate tax. </li></ul></ul><ul><ul><li>State inheritance tax. </li></ul></ul><ul><li>Taxes on earnings. </li></ul><ul><ul><li>Income tax. </li></ul></ul>4-4
  5. 5. What Tax Records to Keep <ul><li>Current tax forms and instruction booklets. </li></ul><ul><li>Social security numbers. </li></ul><ul><li>Copy of previous year’s returns. </li></ul><ul><li>W-2 forms from employers. </li></ul><ul><li>1099 forms (interest, self employment). </li></ul><ul><li>1098 (mortgage interest paid). </li></ul><ul><li>Receipts and documentation for expenses. </li></ul><ul><li>Investment & business expense documents. </li></ul>4-5
  6. 6. Computing Your Tax Liability <ul><li>Step 1: Determining adjusted gross income. </li></ul><ul><ul><li>First identify taxable income - the net income, after deductions, on which income tax is computed. Types of income subject to taxation include… </li></ul></ul><ul><ul><ul><li>Earned income which usually include wages, salary, commissions, fees, tips or bonuses. </li></ul></ul></ul><ul><ul><ul><li>Investment income is money received in the form of dividends, interest or rent from investments. </li></ul></ul></ul><ul><ul><ul><li>Passive income results from business activities in which you do not directly participate such as a limited partnership. </li></ul></ul></ul><ul><ul><ul><li>Alimony, awards, lottery winnings and prizes. </li></ul></ul></ul>4-6
  7. 7. Computing Your Tax Liability (continued) <ul><ul><li>Total income is affected by exclusions. </li></ul></ul><ul><ul><ul><li>Exclusions are amounts not included in gross income. </li></ul></ul></ul><ul><ul><ul><li>Exclusions are also referred to as tax-exempt income, which is income not subject to federal income tax. An example is interest on most state and city bonds. </li></ul></ul></ul><ul><ul><li>Total income is also affected by tax-deferred income. This is income that will be taxed at a later date, such as earnings from an traditional individual retirement account (IRA). </li></ul></ul>4-7
  8. 8. Computing Your Tax Liability (continued) <ul><ul><li>Adjusted gross income is is gross income after certain reductions have been made. These reductions are called adjustments to income, and include the following. </li></ul></ul><ul><ul><ul><li>Contributions to a traditional IRA or Keogh. </li></ul></ul></ul><ul><ul><ul><li>Alimony payments. </li></ul></ul></ul><ul><ul><ul><li>Tax-deferred retirement plans, such as a 401(k)or a 403(b)(7) are a type of tax shelter. </li></ul></ul></ul><ul><ul><ul><ul><li>Tax shelters are investments that provide immediate tax benefits and a reasonable expectation of a future financial return. </li></ul></ul></ul></ul>4-8
  9. 9. Computing Your Tax Liability (continued) <ul><li>Step 2: Computing Taxable Income. </li></ul><ul><ul><li>A tax deduction is an amount subtracted from adjusted gross income (AGI) to arrive at taxable income. </li></ul></ul><ul><ul><li>You can subtract the standard deduction from AGI or itemize your deductions; </li></ul></ul><ul><ul><li>Itemized deductions can include items such as... </li></ul></ul><ul><ul><ul><li>Medical and dental expenses >7.5% of AGI. </li></ul></ul></ul><ul><ul><ul><li>Taxes, interest, contributions and theft loses. </li></ul></ul></ul><ul><ul><ul><li>Moving, job-related, and miscellaneous expenses. </li></ul></ul></ul>4-9
  10. 10. Computing Your Tax Liability (continued) <ul><ul><li>Next subtract exemptions from AGI. </li></ul></ul><ul><ul><ul><li>An exemption is a deduction for yourself, your spouse and qualified dependents. </li></ul></ul></ul><ul><ul><ul><li>The amount of the exemption for the 2001 tax year was $2,900 per person but this amount increases slightly each year. </li></ul></ul></ul><ul><ul><li>After deducting exemptions you have your taxable income. </li></ul></ul>4-10
  11. 11. Computing Your Tax Liability (continued) <ul><li>Step 3: Calculating taxes owed. </li></ul><ul><ul><li>The percent rates are the marginal tax rates on the last dollars of taxable income. </li></ul></ul><ul><ul><ul><li>For example, after deductions and exemptions, a person in the 28% tax bracket pays 28 cents in taxes for every dollar of taxable income in that bracket. </li></ul></ul></ul>4-11
  12. 12. Computing Your Tax Liability (continued) <ul><li>A person’s average tax rate is based on the total tax due divided by taxable income. This rate is less than a person’s marginal tax rate. </li></ul><ul><ul><ul><li>For example, if a person with a taxable income of $30,000 has a total tax bill of $3,000, their average tax rate is 10%. </li></ul></ul></ul><ul><li>Subtract tax credits. </li></ul><ul><ul><ul><li>A tax credit is an amount subtracted directly from the amount of taxes owed, such as the earned income or child and dependent care credits. </li></ul></ul></ul>4-12
  13. 13. Tax Credit versus Tax Deduction 4-13 $100 Tax Credit Reduces Your Taxes by $100 $100 Tax Deduction Amount Your Taxes are Reduced is Based on Your Tax Bracket
  14. 14. W-2 Form <ul><li>Determine tax withheld </li></ul>Making Tax Payments - Withholding 4-14
  15. 15. Filing Your Federal Income Tax Return <ul><li>There are five filing status categories. </li></ul><ul><ul><li>Single or legally separated. </li></ul></ul><ul><ul><li>Married, filing jointly. </li></ul></ul><ul><ul><li>Married, filing separately. </li></ul></ul><ul><ul><li>Head of household. </li></ul></ul><ul><ul><ul><li>Unmarried individual or surviving spouse who maintains a household for a child or dependent relative. </li></ul></ul></ul><ul><ul><li>Qualifying widow or widower (2 years). </li></ul></ul>4-15 You must file if your gross income exceeds the allowed amount. This amount changes each year.
  16. 16. Which Tax Form Should You Use? <ul><li>This is the form for those with the least complicated situations. Quick and easy to file. </li></ul><ul><li>Single or married filing jointly, under age 65 and with no dependents. </li></ul><ul><li>Income consisted of wages, salaries, and tips, and no more than $400 of taxable interest. </li></ul><ul><li>Your taxable income is less than $50,000. </li></ul><ul><li>You do not itemize deductions, or claim any adjustments to income or any tax credits. </li></ul>1040EZ 4-16
  17. 17. Decide Which Tax Form to Use <ul><li>Taxable income less than $50,000. </li></ul><ul><li>Adjustments to income are allowed. </li></ul><ul><li>Tax credits for child care and dependent care are allowed. </li></ul><ul><li>Required to use this form if income is over $50,000. Use if you itemize deductions. </li></ul><ul><li>Used to amend a previously filed return. </li></ul>(continued) 1040A 1040 1040X 4-17
  18. 18. Completing Your Federal Income Tax Return <ul><li>In summary the steps to completing your return include: </li></ul><ul><ul><li>Filing status and exemptions. </li></ul></ul><ul><ul><li>Income. </li></ul></ul><ul><ul><li>Adjustments to income. </li></ul></ul><ul><ul><li>Tax computation. </li></ul></ul><ul><ul><li>Tax credits. </li></ul></ul><ul><ul><li>Other taxes (such as from self-employment) </li></ul></ul><ul><ul><li>Payments (total withholding and other payments). </li></ul></ul>4-18
  19. 19. Completing Your Federal Income Tax Return <ul><ul><li>Determine if you are due a refund or owe tax. </li></ul></ul><ul><ul><ul><li>Refunds can be sent directly to your bank account. </li></ul></ul></ul><ul><ul><li>Sign your return. </li></ul></ul>4-19
  20. 20. Tax Information Sources <ul><li>The IRS has methods of assistance. </li></ul><ul><ul><li>Publications and forms 1-800-TAX-FORM. </li></ul></ul><ul><ul><li>www.irs.gov </li></ul></ul><ul><ul><li>Recorded messages 1-800-829-4477. </li></ul></ul><ul><ul><li>Phone hot line 1-800-829-1040. </li></ul></ul><ul><ul><li>Walk-in service at an IRS office. </li></ul></ul><ul><ul><li>CD-ROM the IRS sells that has forms and pubs. </li></ul></ul><ul><li>Tax publications e.g. Ernst and Young Tax Guide . </li></ul><ul><li>The Internet. </li></ul><ul><ul><li>Tax preparation software companies. </li></ul></ul>4-20
  21. 21. Tax Information Sources <ul><li>Electronic filing. </li></ul><ul><ul><li>Currently over 45 million people file their returns this way. </li></ul></ul><ul><ul><li>Returns are generally received within three weeks. </li></ul></ul><ul><ul><li>Tax preparers charge between $15 and $70 to submit a return for electronic filing. </li></ul></ul><ul><ul><li>Telefile is a way to file by phone if you are using form 1040EZ. </li></ul></ul>(continued) 4-21
  22. 22. Tax Information Sources <ul><li>Tax preparation services. </li></ul><ul><ul><li>Range from a one-person office to large firms such as H & R Block. </li></ul></ul><ul><ul><li>Government-approved tax experts are called enrolled agents. </li></ul></ul><ul><ul><li>Accountants. </li></ul></ul><ul><ul><li>Attorneys. </li></ul></ul><ul><ul><li>If your professional tax preparer makes a mistake, you are still responsible for paying the correct amount, plus any interest and penalties. </li></ul></ul>(continued) 4-22
  23. 23. What if Your Return is Audited? <ul><li>About 0.6% of all returns are audited. </li></ul><ul><li>If you claim large or unusual deductions you are more likely to be audited. </li></ul><ul><li>There are three types of audits. </li></ul><ul><ul><li>Correspondence for minor questions. </li></ul></ul><ul><ul><li>Office audit takes place at an IRS office. </li></ul></ul><ul><ul><li>Field is the most complex, with an IRS agent visiting you at your home, your business or your accountant’s office. </li></ul></ul><ul><li>You have audit rights, including time to prepare for the audit, and clarification. </li></ul>4-23
  24. 24. Tax-Planning Strategies <ul><li>Practice tax avoidance. </li></ul><ul><ul><li>Legitimate methods to reduce your tax obligation to your fair share but no more. </li></ul></ul><ul><ul><li>Financial decisions related to purchasing, investing, and retirement planning are the most heavily affected by tax laws. </li></ul></ul><ul><li>Tax Evasion. </li></ul><ul><ul><li>Illegally not paying all the taxes you owe, such as not reporting all income. </li></ul></ul>4-24
  25. 25. Tax-Planning Strategies <ul><li>To minimize taxes owed... </li></ul><ul><ul><li>If you expect to have the same or a lower tax rate next year, accelerate deductions into the current year. </li></ul></ul><ul><ul><li>If you expect to have a lower or the same tax rate next year, delay the receipt of income until next year. </li></ul></ul><ul><ul><li>If you expect to have a higher tax rate next year, delay deductions since they will have a greater benefit. </li></ul></ul><ul><ul><li>If you expect to have a higher tax rate next year, accelerate the receipt of income to have it taxed at the current lower rate. </li></ul></ul>4-25 (continued)
  26. 26. Tax-Planning Strategies <ul><li>Owning a home is one of the best tax shelters because you can deduct mortgage loan interest and property taxes when you itemize. This reduces your taxable income. </li></ul><ul><li>Use your home equity line of credit to buy a car or consolidate debt, since the interest you pay can be deducted when you itemize. </li></ul><ul><li>Job-related expenses may be allowed as itemized deductions. </li></ul><ul><li>Using tax-exempt investments, such as municipal bonds can help reduce your taxes. </li></ul>(continued) 4-26
  27. 27. Tax-Planning Strategies (continued) <ul><li>Long -term capital gains taxed at a lower rate. </li></ul><ul><ul><li>Held more than one year. </li></ul></ul><ul><li>Put money in tax-deferred investments. </li></ul><ul><ul><li>Series EE U.S. Treasury bonds interest is exempt if used for tuition. </li></ul></ul><ul><ul><li>Tax-deferred annuities. </li></ul></ul><ul><ul><li>Take advantage of tax-deferred retirement plans. </li></ul></ul><ul><ul><ul><li>401(k) plans $12,000 maximum in 2003. </li></ul></ul></ul><ul><ul><ul><li>Establish a Keogh plan if self-employed. </li></ul></ul></ul>4-27
  28. 28. Tax-Planning Strategies (continued) <ul><li>Long-term capital gains on the sale of a home are excluded from taxes up to a certain amount. </li></ul><ul><li>Owning your own business has tax advantages, such as deducting health/life insurance costs, but have to pay self-employment tax (Social Security). </li></ul><ul><li>Children’s investments and income shifting (<$1500) </li></ul><ul><li>Traditional IRA limit was $3,000 in 2002. </li></ul><ul><li>Roth IRA dollars are not taxed when withdrawn. </li></ul><ul><li>Education IRA savings - earnings are tax free. </li></ul><ul><li>529 savings plans are state-run, tax-deferred. </li></ul>4-28
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