Chapter 4 Using Tax Concepts for Planning
Chapter Objectives <ul><li>Explain how to determine your tax filing status </li></ul><ul><li>Explain how to calculate your...
Chapter Objectives <ul><li>Explain how to determine your taxable income, tax liability, and refund or additional taxes owe...
Background on Taxes <ul><li>Financial planning involves decisions  that affect your income </li></ul><ul><ul><li>Whether o...
Background on Taxes <ul><li>Taxes are paid at the federal, state,  and local levels </li></ul><ul><li>The purpose of taxes...
Financial Planning Online: Internal Revenue Service <ul><li>Go to:  http://www. irs . gov </li></ul><ul><li>This Web site ...
Background on Taxes <ul><li>Social Security and Medicare Taxes </li></ul><ul><ul><li>Wages are subject to FICA </li></ul><...
Background on Taxes <ul><li>Social Security and Medicare Taxes </li></ul><ul><ul><li>Your employer matches the amount that...
Background on Taxes <ul><li>Personal income taxes:  taxes imposed  on income earned </li></ul><ul><ul><li>If you earn inco...
Background on Taxes <ul><li>Tax Relief Act of 2001 </li></ul><ul><ul><li>Lower taxes rates phased in gradually until 2010 ...
Filing Status <ul><li>Taxpayers must specify a filing status  for their tax return because different rates are associated ...
Gross Income <ul><li>Gross income:  all reportable income  from any source, including salary, interest income, dividend in...
Gross Income <ul><ul><li>Dividend income:  income received in the form of dividends paid on stocks or mutual funds </li></...
Gross Income <ul><ul><li>Capital loss:  a loss that results from selling  an asset at a lower price than was paid for it <...
Gross Income <ul><li>Determining gross income </li></ul><ul><ul><li>Adjusted gross income:  the amount calculated by adjus...
Deductions and Exemptions <ul><li>Standard deduction:  a fixed amount that can be deducted from adjusted gross income to d...
Deductions and Exemptions Exhibit 4.4: Standard Deduction Amounts for the 2000 Tax Year
Deductions and Exemptions <ul><li>Itemized deductions:  specific expenses that can be deducted to reduce taxable income </...
Financial Planning Online: State Income Tax Rates <ul><li>Go to:  http://taxes.yahoo.com/ statereport .html </li></ul><ul>...
Deductions and Exemptions <ul><ul><li>Real estate tax:  a tax imposed on a home or other real estate in the county where t...
Deductions and Exemptions <ul><ul><ul><li>Expenses for transportation to and from care </li></ul></ul></ul><ul><ul><ul><li...
Deductions and Exemptions <ul><li>Exemption:  an amount that can be deducted for each person who is supported by the incom...
Taxable Income and Taxes <ul><li>Taxable income:  adjusted gross income  less deductions and exemptions </li></ul><ul><li>...
Taxable Income and Taxes <ul><ul><li>Determining your tax liability </li></ul></ul><ul><ul><ul><li>Determine filing status...
Taxable Income and Taxes Exhibit 4.6: Individual Tax Rates for the Year 2000 (Panels A and B)
Taxable Income and Taxes Exhibit 4.6: Individual Tax Rates for the Year 2000 (Panels C and D)
Taxable Income and Taxes <ul><ul><li>Marginal tax bracket:  the tax rate imposed  on any additional (marginal) income earn...
Taxable Income and Taxes <ul><ul><li>Child tax credit:  a tax credit allowed for each child in a household who is less tha...
Taxable Income and Taxes <ul><ul><li>College expense credits:  tax credits for parents who incur college expenses, based o...
Taxable Income and Taxes <ul><ul><li>Earned income credit:  a special credit for taxpayers who earn low incomes; can reduc...
Focus on Ethics:  Reducing Your Taxes <ul><li>Resist the temptation to under  report income </li></ul><ul><li>The IRS usua...
Financial Planning Online: Tax Information Resource <ul><li>Go to:  http://www. taxplanet .com </li></ul><ul><li>This Web ...
How Tax Planning Fits  within Your Financial Plan <ul><li>The key tax planning decisions for building your financial plan ...
Integrating the Key Concepts
Integrating the Key Concepts  <ul><li>Part 1: Financial Planning Tools </li></ul><ul><ul><li>In Chapter 2 we learned about...
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Chapter 4

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Chapter 4

  1. 1. Chapter 4 Using Tax Concepts for Planning
  2. 2. Chapter Objectives <ul><li>Explain how to determine your tax filing status </li></ul><ul><li>Explain how to calculate your gross income </li></ul><ul><li>Demonstrate how deductions and exemptions can be used </li></ul>
  3. 3. Chapter Objectives <ul><li>Explain how to determine your taxable income, tax liability, and refund or additional taxes owed </li></ul><ul><li>Demonstrate how to fill out a tax form and determine your tax liability </li></ul>
  4. 4. Background on Taxes <ul><li>Financial planning involves decisions that affect your income </li></ul><ul><ul><li>Whether or not to take a second job </li></ul></ul><ul><ul><li>Deciding to finance a home </li></ul></ul><ul><ul><li>Investment decisions </li></ul></ul><ul><ul><li>Contributing to a retirement account </li></ul></ul><ul><li>These decisions affect the amount of taxes you pay and therefore affect your wealth </li></ul>
  5. 5. Background on Taxes <ul><li>Taxes are paid at the federal, state, and local levels </li></ul><ul><li>The purpose of taxes is to fund government activities </li></ul><ul><li>The federal tax system is administered by the Internal Revenue Service </li></ul><ul><li>This chapter focuses on the federal income tax process </li></ul>
  6. 6. Financial Planning Online: Internal Revenue Service <ul><li>Go to: http://www. irs . gov </li></ul><ul><li>This Web site provides information about tax rates, guidelines, and deadlines. </li></ul>
  7. 7. Background on Taxes <ul><li>Social Security and Medicare Taxes </li></ul><ul><ul><li>Wages are subject to FICA </li></ul></ul><ul><ul><li>FICA (Federal Insurance Contribution Act): Taxes paid to fund the Social Security System and Medicare </li></ul></ul><ul><ul><li>Medicare: a government health insurance program that covers people over age 65 and provides payments to health care providers in the case of illness </li></ul></ul>
  8. 8. Background on Taxes <ul><li>Social Security and Medicare Taxes </li></ul><ul><ul><li>Your employer matches the amount that is withheld from your wages </li></ul></ul><ul><ul><ul><li>Social Security taxes equal 6.2% of your salary up to a maximum level of $84,900 </li></ul></ul></ul><ul><ul><ul><li>Medicare taxes are 1.45 % of your entire salary </li></ul></ul></ul><ul><ul><li>Self-employed people must pay both parts of these taxes themselves — 15.3% </li></ul></ul>
  9. 9. Background on Taxes <ul><li>Personal income taxes: taxes imposed on income earned </li></ul><ul><ul><li>If you earn income you must file a Form 1040 to determine your tax liability </li></ul></ul><ul><ul><li>Filing deadline is April 15 of each year </li></ul></ul>
  10. 10. Background on Taxes <ul><li>Tax Relief Act of 2001 </li></ul><ul><ul><li>Lower taxes rates phased in gradually until 2010 </li></ul></ul><ul><ul><li>Impact various adjustments made to determine personal income taxes </li></ul></ul><ul><ul><li>Designed to provide both a short-term stimulus to the economy and long-term tax relief for individual taxpayers </li></ul></ul>
  11. 11. Filing Status <ul><li>Taxpayers must specify a filing status for their tax return because different rates are associated with each status. </li></ul><ul><ul><li>Single </li></ul></ul><ul><ul><li>Married filing joint return </li></ul></ul><ul><ul><li>Married filing separate return </li></ul></ul><ul><ul><li>Head of household </li></ul></ul><ul><ul><li>Qualifying widow(er) with dependent child </li></ul></ul>
  12. 12. Gross Income <ul><li>Gross income: all reportable income from any source, including salary, interest income, dividend income, and capital gains received during the tax year </li></ul><ul><ul><li>Wages and Salaries — including bonuses, but excluding contributions to an employee sponsored retirement account </li></ul></ul><ul><ul><li>Interest income: interest earned from investments or loans to other individuals </li></ul></ul>
  13. 13. Gross Income <ul><ul><li>Dividend income: income received in the form of dividends paid on stocks or mutual funds </li></ul></ul><ul><ul><li>Capital gain: income earned when an asset is sold at a higher price than was paid for it </li></ul></ul><ul><ul><ul><li>Short-term capital gain: a gain on assets that were held less than 12 months </li></ul></ul></ul><ul><ul><ul><li>Long-term capital gain: a gain on assets that were held for 12 months or longer </li></ul></ul></ul>
  14. 14. Gross Income <ul><ul><li>Capital loss: a loss that results from selling an asset at a lower price than was paid for it </li></ul></ul><ul><ul><li>Capital gains tax: the tax that is paid on a gain earned as a result of selling an asset for more than the purchase price </li></ul></ul>
  15. 15. Gross Income <ul><li>Determining gross income </li></ul><ul><ul><li>Adjusted gross income: the amount calculated by adjusting gross income for contributions to individual retirement accounts, alimony payments, interest paid on student loans, and other special circumstances </li></ul></ul><ul><li>All of these items related to gross income are reported on Form 1040 </li></ul>
  16. 16. Deductions and Exemptions <ul><li>Standard deduction: a fixed amount that can be deducted from adjusted gross income to determine taxable income </li></ul><ul><ul><li>Not affected by income </li></ul></ul><ul><ul><li>Affected by filing status and age </li></ul></ul><ul><ul><li>Marriage penalty: term used to describe the fact that many two-income married people pay more in taxes than if they were single </li></ul></ul>
  17. 17. Deductions and Exemptions Exhibit 4.4: Standard Deduction Amounts for the 2000 Tax Year
  18. 18. Deductions and Exemptions <ul><li>Itemized deductions: specific expenses that can be deducted to reduce taxable income </li></ul><ul><ul><li>Interest expense: interest paid on borrowed money — primarily interest on mortgages and student loans </li></ul></ul><ul><ul><li>State income tax: an income tax imposed by some states on people who receive income from employers in that state </li></ul></ul>
  19. 19. Financial Planning Online: State Income Tax Rates <ul><li>Go to: http://taxes.yahoo.com/ statereport .html </li></ul><ul><li>This Web site provides income tax rates and information on personal exemptions for each state. </li></ul>
  20. 20. Deductions and Exemptions <ul><ul><li>Real estate tax: a tax imposed on a home or other real estate in the county where the property is located </li></ul></ul><ul><ul><li>Medical expenses </li></ul></ul><ul><ul><ul><li>Amounts paid for prevention, diagnosis or alleviation of physical or mental defects or illness </li></ul></ul></ul><ul><ul><ul><li>Amounts paid to affect any structure or function of the body </li></ul></ul></ul>
  21. 21. Deductions and Exemptions <ul><ul><ul><li>Expenses for transportation to and from care </li></ul></ul></ul><ul><ul><ul><li>Accident and health insurance premiums </li></ul></ul></ul><ul><ul><li>Charitable gifts </li></ul></ul><ul><ul><li>Other expenses </li></ul></ul><ul><ul><ul><li>Casualties or thefts </li></ul></ul></ul><ul><ul><ul><li>Job-related expenses </li></ul></ul></ul><ul><li>Compare the total allowable itemized deductions to the standard deduction and use the larger </li></ul>
  22. 22. Deductions and Exemptions <ul><li>Exemption: an amount that can be deducted for each person who is supported by the income reported on a tax return </li></ul><ul><ul><li>Usually one exemption each for the filer, the spouse and each dependent child </li></ul></ul><ul><ul><li>Deducted from gross income to determine taxable income </li></ul></ul>
  23. 23. Taxable Income and Taxes <ul><li>Taxable income: adjusted gross income less deductions and exemptions </li></ul><ul><li>Taxes </li></ul><ul><ul><li>Depends on taxable income and filing status </li></ul></ul><ul><ul><li>Progressive: a term used to characterize a tax system where a positive relationship exists between an individual’s income level and tax rate </li></ul></ul>
  24. 24. Taxable Income and Taxes <ul><ul><li>Determining your tax liability </li></ul></ul><ul><ul><ul><li>Determine filing status and follow the instructions on the tax schedule </li></ul></ul></ul><ul><ul><ul><li>Tax Liability = Tax on Base + [Percentage on Excess over the Base x (Taxable Income – Base)] </li></ul></ul></ul>
  25. 25. Taxable Income and Taxes Exhibit 4.6: Individual Tax Rates for the Year 2000 (Panels A and B)
  26. 26. Taxable Income and Taxes Exhibit 4.6: Individual Tax Rates for the Year 2000 (Panels C and D)
  27. 27. Taxable Income and Taxes <ul><ul><li>Marginal tax bracket: the tax rate imposed on any additional (marginal) income earned </li></ul></ul><ul><li>Tax credits: amounts that offset taxes; the full amount of the tax credit is subtracted from taxes owed </li></ul>
  28. 28. Taxable Income and Taxes <ul><ul><li>Child tax credit: a tax credit allowed for each child in a household who is less than 17 years old (reduced or eliminated for households in high-income brackets) </li></ul></ul><ul><ul><ul><li>Gradually increasing from $600 in 2001 to $1,000 in 2010 </li></ul></ul></ul><ul><ul><ul><li>Available as a refund to low-income workers who owe no income tax </li></ul></ul></ul>
  29. 29. Taxable Income and Taxes <ul><ul><li>College expense credits: tax credits for parents who incur college expenses, based on the amount of financial support they provide </li></ul></ul><ul><ul><ul><li>Section 529 College Savings Plan </li></ul></ul></ul><ul><ul><ul><ul><li>Allows tax benefits for parents who set aside money for their children’s future college expenses </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Available to all parents, regardless of income </li></ul></ul></ul></ul>
  30. 30. Taxable Income and Taxes <ul><ul><li>Earned income credit: a special credit for taxpayers who earn low incomes; can reduce the amount of taxes owed </li></ul></ul><ul><ul><li>Other tax credits are also available, for example for child care and adoptions </li></ul></ul>
  31. 31. Focus on Ethics: Reducing Your Taxes <ul><li>Resist the temptation to under report income </li></ul><ul><li>The IRS usually uncovers such behavior </li></ul><ul><li>There are many legal ways to reduce taxes </li></ul><ul><li>File on time </li></ul>
  32. 32. Financial Planning Online: Tax Information Resource <ul><li>Go to: http://www. taxplanet .com </li></ul><ul><li>This Web site provides useful information on the most recent tax rates, forms, laws, and issues. Search for a particular tax topic in which you are interested. </li></ul>
  33. 33. How Tax Planning Fits within Your Financial Plan <ul><li>The key tax planning decisions for building your financial plan are: </li></ul><ul><ul><li>What tax savings are currently available to you? </li></ul></ul><ul><ul><li>How can you increase your tax savings in the future? </li></ul></ul>
  34. 34. Integrating the Key Concepts
  35. 35. Integrating the Key Concepts <ul><li>Part 1: Financial Planning Tools </li></ul><ul><ul><li>In Chapter 2 we learned about personal financial statements </li></ul></ul><ul><ul><li>In Chapter 3 we learned about time value of money </li></ul></ul><ul><ul><li>In Chapter 4 we learned about tax planning </li></ul></ul><ul><li>Part 2: Liquidity Management </li></ul><ul><li>Part 3: Financing </li></ul><ul><li>Part 4: Protecting Your Wealth </li></ul><ul><li>Part 5: Investing </li></ul><ul><li>Part 6: Retirement and Estate Planning </li></ul>

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