Chapter3TaxesinYourFinancialPlanCopyright

?2010byTheMcGraw-HillCompanies,Inc.Allrightsreserved.McGraw-Hill/IrwinTaxesinYourFinancialPlan

Identifythemajortaxespaidbypeople

inoursocietyCalculatetaxableincomeandtheamountowedforfederalincometaxPrepareafederalincometaxreturnSelectappropriatetaxstrategiesforvariouslifesituationsChapterObjectives3-2Startplanningfortaxes….KnowcurrenttaxlawsastheyaffectyouMaintaincompleteandappropriatetaxrecordsMakepurchaseandinvestmentdecisionsthatreduceyourtaxliabilityGoal:Payingyourfairsharebutstilltakingadvantageoftaxbenefits.Objective1

IdentifytheMajorTaxesPaidbyPeopleinOurSociety

PlanningYourTaxStrategy3-3

TypesofTaxesTaxesonPurchasesSalestax&excisetaxTaxesonPropertyRealestatepropertytaxPersonalpropertytaxTaxesonWealthFederalestatetaxStateinheritancetaxTaxesonEarningsIncometaxandSocialSecurity3-4WhatTaxRecordstoKeepCurrenttaxformsandinstructionbookletsSocialsecuritynumbersCopyofpreviousyear’sreturnsW-2formsfromemployers1099forms(interest,selfemployment)1098(mortgageinterestpaid)ReceiptsanddocumentationforexpensesInvestment&businessexpensedocuments

3-5Objective2

CalculateTaxableIncomeandtheAmountOwedforFederalIncomeTaxStep1:DetermineAGI

AGI=AdjustedGrossIncome

TaxableIncome Netincome=incomeonwhichtaxis computed Grossincomeminusdeductions

3-6Objective2

CalculateTaxableIncomeMainComponentsofGrossIncomeEarnedincome

Usuallyincludeswages,salary,commissions,fees,tipsorbonusesInvestmentincome

Moneyreceivedintheformofdividends,interestorrentfrominvestmentsPassiveincome

ResultsfrombusinessactivitiesinwhichyoudonotdirectlyparticipatesuchasalimitedpartnershipOtherincomeAlimony,awards,lotterywinningsandprizes

3-7Objective2

CalculateTaxableIncomeTotalincomeisaffectedby:

ExclusionsAmountsexcludedfromgrossincomeAlsoreferredtoastax-exemptincome;incomenotsubjecttofederalincometaxExample=interestonmoststateandcitybondsTax-deferredincome

Incomethatwillbetaxedatalaterdate,suchasearningsfromantraditionalindividualretirementaccount(IRA)

3-8Objective2

CalculateTaxableIncomeAdjustedgrossincome(AGI)GrossincomereducedbycertainreductionsThebasisforcomputingvariousdeductionsAdjustmentstoincomeReduceAGIContributionstoatraditionalIRAorKeoghAlimonypayments

3-9Objective2

CalculateTaxableIncomeStep2:ComputingTaxableIncomeTaxdeduction=amountsubtractedfromadjustedgrossincome(AGI)toarriveattaxableincomeStandarddeductionItemizeddeductions

3-10CalculateTaxableIncome

ItemizedDeductionsMedical&dentalexpenses(>7.5%ofAGI)TaxesInterestContributionsCasualtyandtheftlosesMovingexpensesJob-relatedandothermiscellaneousexpenses

3-11CalculateTaxableIncome

ExemptionsExemptions

subtractedfromAGIAnexemption=adeductionforyourself,yourspouseandqualifieddependentsTheamountoftheexemption

forthe2008taxyearis

$3,500perpersonAfterdeductingexemptionsyou

haveyourtaxableincome

3-12Objective2

CalculateTaxesOwedStep3:CalculatingtaxesowedTaxtablerates=marginalratesThetaxratepaidonthelast(ornext)dollaroftaxableincome.

Example:Afterdeductionsandexemptions,apersoninthe35%taxbracketpays35centsintaxesforeverydollaroftaxableincomeinthatbracket.

3-132008IRSTaxBrackets3-142008IRSTaxExampleTaxonasingletaxpayer’sincomeof$40,0003-15Objective2

CalculateTaxesOwed

Theaveragetaxrate=thetotaltaxduedividedbytaxableincomeAveragetaxrate<marginaltaxrateExample:Taxableincome=$40,000Totaltaxbill=$6,344Averagetaxrate=15.9%($6,344/$40,000)

3-16Objective2

CalculateTaxesOwedAlternativeminimumtax

(AMT)PaidbytaxpayerswithhighamountsofcertaindeductionsandvarioustypesofincomeDesignedtoensurethatthosewhoreceivetaxbreaksalsopaytheirfairshareoftaxes

3-17Objective2

CalculateTaxesOwedTaxcreditsAmountsubtracteddirectlyfromtheamountoftaxesowedExamples:EarnedincomecreditsForeigntaxcreditsChildanddependentcarecreditsRetirementtaxcreditsAdoptiontaxcreditsHopeScholarshipandLifetimeLearningcredits

3-18TaxCreditversusTaxDeduction$100TaxCreditReducesYourTaxesby$100$100TaxDeductionAmountYourTaxesareReducedisBasedonYourTaxBracket

3-19DeterminingYourTaxLiability3-20Objective2

CalculateTaxesOwedStep4:

MakingTaxPayments

PayrollWithholdingBasedonthenumberofexemptionsandtheexpecteddeductionsclaimedEstimatedQuarterlyPaymentsEstimatedtaxpaymentsmadethroughouttheyearbasedonincomemadeduringtheyearandreportedonForm1099.

3-21Objective2

CalculateTaxesOwedStep5:

WatchingDeadlines-AvoidingPenaltiesForm4868automaticsix-monthextensionSubmitestimatedtaxduewithForm4868byApril15Penalties&InterestUnderpaymentofquarterlyestimatedtaxesmayrequirepayinginterestontheamountowedUnderpaymentduetonegligencecanresultinpenaltiesof50to75percent3-22Objective3

PrepareaFederalIncomeTaxReturnFivefilingstatuscategories:SingleorlegallyseparatedMarried,filingjointlyMarried,filingseparatelyHeadofhouseholdUnmarriedindividualorsurvivingspousewhowithachildordependentrelativeQualifyingwidoworwidower(2years)EverycitizenorresidentofU.S.andeveryU.S.citizenwhoisaresidentofPuertoRicoisrequiredtofileincometax.

3-23WhichTaxFormShouldYouUse?≈400federaltaxformsandschedulesBasicallythechoiceisbetween3forms1040EZ1040A1040Whichformtouse?TypeofincomeAmountofincomeNumberofdeductionsComplexityoftaxsituation

3-24CompletingtheFederalIncomeTaxReturnFilingstatusandexemptionsIncomeAdjustmentstoincomeTaxcomputationTaxcreditsOthertaxes(suchasfromself-employment)Payments(totalwithholdingandotherpayments)RefundoramountyouoweRefundscanbedirectlydepositedtoyourbankaccount.Paymentsmaybedirectlydebitedfromyourbankaccount.Yoursignature=Mostcommonfilingerror

3-25HowdoIFileMyStateTaxReturn?Allbut7stateshaveastateincometaxMoststatestaxraterangesfrom1to10percentStatesusuallyrequireincometaxreturnstobefiledwhenthefederalincometaxreturnisdue3-26HowDoIFileMyTaxesOnline?TaxpreparationsoftwareTurboTaxandTaxCut

aretwoofthemostpopulartaxpreparationsoftwarepackagesUsingsoftwarecansave10ormorehoursTaxsoftware

allowsyoutocompleteneededtaxformsPrintandmailtheformsorfile

onlinee-filingrefundsusuallytake3weeksCostfore-filing=$5-$403-27HowDoIFileMyTaxesOnline?FreeFileAllianceOnlinetaxpreparationandfilingfreetomanytaxpayers-goto“FreeFile”Variousqualificationcriteriatofilefree;use“GuideMetoaService”Connecttoselectedfirm’swebsiteUseform’sonlinesoftwaretoprepareandfiletaxreturn3-28AvailableTaxAssistanceSourcesIRSServicesPublicationsandforms1-800-TAX-FORMRecordedmessages1-800-829-4477Phonehotline1-800-829-1040Walk-inserviceatanIRSoffice

3-29AvailableTaxAssistanceSourcesTaxpublications

e.g.ErnstandYoungTaxGuideandJ.K.Lasser’sYourIncomeTaxTheInternetTaxpreparationsoftwarecompaniesTaxPreparationServicesTaxpreparerschargebetween$40and$2,000dependingonthecomplexityofthereturnOver40millionU.S.taxpayerspaysomeoneelsetodotheirtaxes3-30TypesofTaxPreparationServicesOne-person,localofficestolargefirmssuchasH&RBlock“Enrolledagents”=Government-approvedtaxexpertsCPATaxAccountantsAttorneys3-31EvaluatingTaxServicesFactorstoconsider:Trainingandexperienceofthetaxprofessional?Feeforpreparingtaxesandhowdetermined?Questionabledeductionssuggested?Ifreturnisauditedwillthepreparerrepresenttheclient?Istaxpreparationthemainbusinessactivityorisitafrontforotherfinancialproducts?3-32TaxServiceWarningsUltimatelyyouareresponsibleforprovidingcompleteandaccurateinformationIfyourprofessionaltaxpreparermakesamistake,youarestillresponsibleforpayingthecorrectamount,plusanyinterestandpenalties.HiringataxpreparerdoesnotguaranteethatyouwillpaythecorrectamountBewareoftaxpreparersthatofferrefundsinadvance“Refundanticipationloans”canchargeinterestratesinexcessof300%3-33WhatifYourReturnisAudited?≈0.6%ofallreturnsareauditedIfyouclaimlargeorunusualdeductionsyouaremorelikelytobeaudited.Threetypesofaudits:CorrespondenceauditforminorquestionsOfficeaudittakesplaceatanIRSofficeFieldauditisthemostcomplex,withanIRSagentvisitingyouatyourhome,yourbusinessoryouraccountant’soffice

3-34WhatifYourReturnisAudited?AuditRightsRequesttimetoprepareClarificationofitemsbeingquestionedRighttoappealauditresultsWhenAudited:Decidewhethertobringyoutaxpreparer,accountantorlawyerBeontimeforyou’reappointment;bringonlyrelevantdocumentsPresentevidenceinalogical,calmandconfidentmanner;maintainapositiveattitudeMakesureyourinformationisconsistentwithtaxlawKeepyouranswersaimedattheauditor’squestions

3-35Objective4

SelectAppropriateTaxStrategies TaxPlanningStrategiesPracticetaxavoidanceLegitimatemethodstoreduceyourtaxobligationtoyourfairsharebutnomoreFinancialdecisionsrelatedtopurchasing,investing,andretirementplanningarethemostheavilyaffectedbytaxlaws

TaxEvasionIllegallynotpayingallthetaxesyouowe,suchasnotreportingallincome

3-36TaxPlanningStrategies

MinimizingTaxesIfyouexpectThenyoushouldBecauseThesameoralowertaxratenextyearAcceleratedeductionsintothisyearGreaterbenefittohigherrateThesametaxratenextyearDelayincomeintonextyearDelaypayingtaxesAhighertaxratenextyearDelaydeductionsGreaterbenefitAccelerateincomeTaxedatlowerrate3-37Tax-PlanningStrategies

ConsumerPurchasingHomeownership

OneofthebesttaxsheltersDeductmortgageloaninterestandpropertytaxesReducesyourtaxableincomeUsehomeequitylineofcredittobuyacarorconsolidatedebtInterestdeductible

3-38Tax-PlanningStrategies

ConsumerPurchasingJob-relatedexpensesmaybeallowedasitemizeddeductionsUnionduesBusinesstoolsJobsearchcostsHealthcareexpenseslikeFSA’s(FlexibleSpendingAccounts)allowyoutoreduceyourtaxableincomewhenpayingforhealthrelatedexpenses

3-39Tax-PlanningStrategies

Investment