Simple introduction to taxes

A way, way, way too simple introduction to income, capital gains, estate, gift, and generation skipping taxes
Russell James, J.D., Ph.D.,
Dept. of Personal Financial Planning, Texas Tech University

We pay taxes
on money we earn.

We pay taxes
on money we earn.
We call these income taxes.

We pay taxes
on money we earn.
We pay taxes when we sell something for more than we paid for it.

We pay taxes
on money we earn.
We pay taxes when we sell something for more than we paid for it.
We call these capital gains taxes.

The federal government charges these taxes

The federal government charges these taxes
Most states do too

We (sometimes) pay taxes on money we leave to other people when we die.

We call these estate taxes.

To prevent tax free transfer of estates before death, we (sometimes) pay taxes on gifts to others.

We call these gift taxes.

The percentage we pay in taxes is not flat.

As income
increases the
income tax
percentage
increases.

As income
increases the
capital gain tax
percentage
increases.

As estate size increases the
estate tax
percentage
increases.

As gift size
increases the
gift tax
percentage
increases.

2011 federal income tax brackets for a single person

How much taxes are owed on $5,000?

$5,000 x 10% = $500

($8,500 x 10%) +
($1,000 x 15%)
$1,000

($850) +
($150)
$1,000

($8,500 x 10%) +
(($34,500-$8,500) x 15%) +
(($40,000-$34,500) x 25%)
$6,125

($8,500 x 10%) +
($26,000 x 15%) +
($5,500 x 25%)
$6,125

($850) +
($3,900) +
($1,375)
$6,125

A tax deduction reduces taxable income

If I have $10,000 of taxable income
then get a $1,000 deduction
How much taxable
income do I have?

How much taxable
income do I have?
$10,000 - $1,000 = $9,000

How much taxable
income do I have?

How much taxable
income do I have?
$100,000 - $1,000 = $99,000

How much is a deduction worth?

How much is a deduction worth?
The amount of the deduction
X The marginal tax rate
Deduction value

Taxpayers can take either itemized deductions or the standard deduction
Standard Deduction (2011)
$5,800 single
Actual itemized deductions

If itemized deductions total less than the standard deduction, they are not used.
Standard Deduction (2011)
$5,800 single
Actual itemized deductions
$4,000

If all itemized deductions combined are less than the standard deduction, they are worth nothing

For the following examples, we will keep it simple by assuming the taxpayer is already itemizing deductions

How much is a $1,000 deduction worth to a person with $8,000 of taxable income?

$1,000 x 10% = $100

$1,000 x 28% = $280

$1,000 x 35% = $350

($500 x 10%) +
($500 x 15%)
$125

How much is a $1,000 deduction worth to a person with $9,000 of taxable income living in Utah (with a 5% flat income tax)?

($500 x (10%+5%)) +
($500 x (15%+5%))
$175

($500 x 15%) +
($500 x 20%)
$175

($75) +
($100)
$175

$1,000 x 40% = $400

If I sell something for more than I paid for it, that profit is taxed as a capital gain

If I sell something for more than I paid for it, that profit is taxed as a capital gain
What I sold it for –
What I paid for it
Capital gain

What I sold it for – Basis = Capital gain
Instead of
“What I paid for it”,
we use the term
Basis

What I sold it for – Basis = Capital gain
Basis is
+ what I paid for it
+ any money I spent improving it
- any depreciation tax deductions I have already taken on it

If I owned the item for more than one year, it is a long-term capital gain

We call these gift taxes.

There are no estate or gift taxes on up to $5,000,000 of transfers.
The top rate is 35%.

For anyone dying after Dec. 31, 2012, there are no estate or gift taxes on up to $1,000,000 of transfers.
The top rate is 55%.

Transfers to grandchildren with living parents, in excess of $5,000,000 total, may create generation skipping transfer taxes. This adds another 35% tax.

After Dec. 31, 2012, transfers to grandchildren with living parents, in excess of $1,000,000 total, may create generation skipping transfer taxes. This adds another 55% tax.

If, after Dec. 31, 2012, I earn an extra $100,000 to give to my grandchildren, how much will they get (if I live in California at all top marginal rates)?

If, after Dec. 31, 2012, I earn an extra $100,000 to give to my grandchildren, how much will they get (if I live in California at all top marginal rates)?
Fed. Income Tax
($100,000 x 39.6%) = $39,600
Cali. Income Tax
($100,000 x 10.3%) = $10,300
Gift tax
($50,100 x 55%) = $27,550
GST tax
($22,550 x 55%) = $12,402
$10,147

A way, way, way too simple introduction to income, capital gains, estate, gift, and generation skipping taxes
Russell James, J.D., Ph.D.,
Dept. of Personal Financial Planning, Texas Tech University

Simple introduction to taxes

by Russell James on Aug 24, 2011

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