© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Personal Finance:Personal Finance:An Integrated Planning ApproachAn Integrated Planning Approach
Winger & FrascaWinger & Frasca
Chapter 4Chapter 4TaxesTaxes
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© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Major TopicsMajor Topics
Determining Your Federal Income Tax Other Aspects of the Federal Income Tax Planning to Reduce Your Income Taxes
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Figure 4.2 Federal Income Tax FormulaFigure 4.2 Federal Income Tax FormulaGlobal Income
Less Nontaxable Exclusions
Gross Income
{
Adjustments to Gross Income{Adjusted Gross Income
{ Less personal and dependency deductionsLess itemized or standard deductions
Taxable Income
{
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Figure 4.2 Federal Income Tax FormulaFigure 4.2 Federal Income Tax FormulaTaxable 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
{
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Gross IncomeGross Income
Sources of income that are subject to the federal income tax
Primary Sourceswages and salaries alimony interest
capital gains dividends pensions
business income rentals royalties
partnerships
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Adjusted Gross IncomeAdjusted Gross Income
Gross income plus or minus
certain adjustments
Examples of possible exclusions
IRA contributions Moving expenses
Alimony paid
Self-employed health insurance
One-half of self-employment tax
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Taxable IncomeTaxable Income
equalsequals
Adjusted gross income less – personal and dependency exemptions– personal deductible expenses
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Taxable IncomeTaxable Income
Personal and dependency exemptions – Each spouse on a joint return – Any of the taxpayer’s dependents– $2,900 for each dependent in 2001
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Standard Deduction for 2001Standard Deduction for 2001
Filing Status Standard Deduction
Married filing jointly or Qualifying widow(er)
$7,650
Head of household $6,650
Single $4,550
Married filing separately $3,800
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Typical Itemized DeductionsTypical Itemized Deductions
Medical expenses– in excess of 7.5% of adjusted gross income
State and local income taxes Personal property taxes
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Typical Itemized DeductionsTypical Itemized Deductions
Interest on home mortgages (limitations) Charitable contributions (limitations) Casualty and theft losses (limitations) Miscellaneous business related expenses
– in excess of 2% of adjusted gross income
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2001 Tax Rate Schedule2001 Tax Rate ScheduleSingle TaxpayersSingle Taxpayers
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2001 Tax Rate Schedule2001 Tax Rate ScheduleJoint TaxpayersJoint Taxpayers
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A direct deduction against your tax liability
Examples of possible credit– Credit for the elderly (include disability credit)– Earned income credit– Education tax credit– Child and dependent care expenses– Jobs credit
Tax CreditsTax Credits
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Tax Rate MeasuresTax Rate Measures
Average tax rate– total tax liability divided by total income
Marginal tax rate– additional tax liability divided by additional
income– the tax rate on an incremental dollar of income
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Capital Gains and LossesCapital Gains and Losses
Gain or loss resulting from the sale of a capital asset
Capital asset is an asset held for pleasure or investment
Capital gains and losses receive special tax treatment
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Taxes on Capital GainsTaxes on Capital Gains
The holding period will determine the tax rate on capital gains– Gains or losses on a capital asset held less than one
year are “short-term” – Gains or losses on a capital asset held one year or
more are “long-term” Short-term gains or losses on
financial assets are treated like changes to ordinary income
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Taxes on Capital GainsTaxes on Capital Gains
The maximum tax rate for the gain on most long-term financial assets will depend upon your marginal tax rate– The rate is 10% if you are in the 15% marginal
tax bracket and 20% if you are in a higher tax bracket
– This does not apply to collectibles which are taxed at a maximum rate of 28%
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Tax Treatment on LossesTax Treatment on Losses
Capital losses on personal use assets are not deductible
Capital losses on financial assets may be deducted up to a $3,000 limit– Losses not deducted in the current year may be
carried forward to the next tax year
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Selling Your HomeSelling Your Home
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
To get the full exclusion you must have owned the home for the last two years, and
used it as your main home for two recent years
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Special Considerations for StudentsSpecial Considerations for Students
Scholarships and Fellowships Employment related advantages Education Tax Credits Other Special Advantages
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Scholarships and FellowshipsScholarships and Fellowships
Awards that cover purely educational expenses that lead to a degree are most likely not taxable
Payments for noneducational expenses are taxable– subsistence allowances paid to ROTC students
in advanced training is an exception
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Employment Related AdvantagesEmployment Related Advantages
A qualified tuition reduction– tuition reduction provided to employee or
relative of employee
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Employment Related AdvantagesEmployment Related Advantages
Qualifying educational expenses– Must be required by employer to maintain or
improve the skills needed in your current job– Cannot be used to prepare you for the minimal
skills needed in your current position or prepare you for a new job
– Itemized deduction that must exceed 2% of your adjusted gross income
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Employment Related AdvantagesEmployment Related Advantages
Qualified educational assistance– Includes educational expenses paid for by your
employer– Your employer can tell you which expenses are
qualified
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Education Tax CreditsEducation Tax Credits
Hope Scholarship Credit– For first two years of postsecondary education– Must be enrolled at least half-time in a degree
program– Limit on maximum credit and phased out at
higher incomes
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Education Tax CreditsEducation Tax Credits
Lifetime Learning Credit– May receive this credit in years you do not
qualify for the Hope Scholarship Credit– Limit on maximum credit and phased out at
higher incomes
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Other Special Tax AdvantagesOther Special Tax Advantages
Temporary College Deduction Education IRA State and Private Tuition Programs Student Loan Interest Education Savings Bonds
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Plan to Reduce Your TaxesPlan to Reduce Your Taxes
Invest where you receive tax-advantaged income
Take capital losses quickly Split your income Stagger income and expenses Defer income to later years
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Sources of Tax-Advantaged IncomeSources of Tax-Advantaged Income
Municipal bonds – tax exempt interest earned
Home ownership– tax exempt interest paid– capital gains exemption
Real estate investments– depreciation– loss deductions
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Defer Income to Later YearsDefer Income to Later Years
Pension plans Tax-deferred annuities US Treasury Series EE Bonds
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Other Important TaxesOther Important Taxes
Social Security Taxes State and Local Taxes
– income taxes– property taxes– sales taxes
Estate and Gift Taxes– federal & state estate and gift taxes– state inheritance taxes
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Death TaxesDeath Taxes
A tax on property either transferred or received at death
Estate tax– imposed on property of deceased before
transfer
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Death TaxesDeath Taxes
Gift tax– on gifts transferred during life
Inheritance tax– paid by beneficiary on property received
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Estate Tax ExemptionEstate Tax Exemption
Death in Top Rate Exemption
2002 2003 2004 2005 2007 2008 2009 2010
2011+
50% 49% 48% 46% 45% 45% 45%
Repealed 55%
$1 million $1 million
$1.5 million $2 million $2 million $2 million
$3.5 million
$1 million
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
Federal Income TaxesFederal Income Taxes
Let goods that have appreciated in market value transfer at death
Don’t bequeath property that has depreciated in value
Be aware of how ownership can affect tax liabilities
© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.
NextNextChapter 5Chapter 5
Cash ManagementCash Management