Chapter 4: Managing Income Taxes Garman/Forgue Personal Finance Ninth Edition PPT slide program...

Chapter 4:Managing Income Taxes

Garman/Forgue

Personal FinanceNinth Edition

PPT slide program prepared by Amy Forgue and Ray Forgue.

Copyright ©Houghton Mifflin Company. All rights reserved. 4 - 2

Learning Objectives

1. Explain the nature of progressive income taxes and the marginal tax rate.

2. Differentiate among the eight steps involved in calculating your federal income taxes.

3. Use appropriate strategies to avoid overpayment of income taxes.


Introduction

• Tax Planning: Seeking legal ways to reduce, eliminate, or defer income taxes.

• Taxable Income: the income upon which income taxes are levied.


Taxes

• Progressive income taxes and the marginal tax rate– Taxes – Internal Revenue Service (or IRS)– Internal Revenue Code

• The progressive nature of the federal income tax– Progressive tax– Regressive tax


The Marginal Tax Rate

• Marginal tax bracket (or MTB)

• Marginal tax rate

• Indexing


Marginal Tax Rate and Financial Decisions

• Your effective marginal tax rate is probably 43%.

• Your average tax rate is lower.– Average tax rate: Proportion of total

income paid in income taxes.


8 Steps in Calculating Your Income Taxes

1. Determine your total income.

2. Determine and report gross income after subtracting exclusions.

3. Subtract adjustments to income.

4. Subtract either the IRS’s Standard Deduction for your tax status or itemize your deductions.


8 Steps in Calculating Your Income Taxes

5. Subtract the value of your personal exemptions.

6. Determine your preliminary tax liability.

7. Subtract tax credits for which you qualify.

8. Calculate the balance due the IRS or the amount of your refund.


Total Income

• Total Income: Compensation from all sources.


Total Income

• Income to include:– Wages and Salaries– Commissions– Tips Earned– Gambling and Lottery Winnings

• Include capital gains and losses in Total Income.– Long-term gain (or loss)


Gross Income

• Determine and report your gross income after subtracting exclusions.


Gross Income

• Income to exclude:– Gifts

– Inherited money or property

– Income from a carpool

– Federal income tax refunds


Gross Income

• More income to exclude:– Employee contributions to flexible

spending accounts

– Reimbursements from flexible spending accounts

– Child support payments received


Subtract Adjustments to Income

• Adjustments to Income

• Adjusted Gross Income (or AGI)


Deductions

• Subtract either the IRS’s standard deduction for your tax status or your itemized deductions.

• Standard deduction depends on filing status.– $5350 for single individuals– $10,700 for married couples


Deductions

• Itemized deductions: Medical and dental expenses


Deductions

• Itemized deductions: Taxes you paid

– Real Estate Property Taxes (home or land)

– Personal Property Taxes

– State, Local, and Foreign Income Taxes

– State and Local Sales Taxes (instead of state and local income taxes)


Deductions

• Itemized deductions: Taxes you paid

– Interest Paid on Home Mortgage Loans

– “Points”

– Interest Paid on Home-Equity Loans


Deductions

• Itemized deductions: Interest you paid

– Interest paid on loans used for investments

– Mortgage insurance premiums on new loans after January 1, 2007


Deductions

• More itemized deductions:

– Gifts to charity

– Casualty and theft losses


• Miscellaneous deductions in excess of 2% of adjusted gross income

• Other miscellaneous deductions allowed at 100%:– Gambling losses– Business expenses for workers with

disabilities

Deductions


Exemptions

• Exemption (or Personal Exemption)

• Subtract the value of your personal exemptions.

• Each exemption reduces taxable income by $3400.


Exemptions

• Claiming another person as an exemption

• What if you are claimed as an exemption?– If someone else claims you, you cannot

claim yourself.– The opposite is also true.


Tax Liability

• Determine your preliminary tax liability.

• Subtract tax credits for which you qualify.– Tax Credit: Dollar-for-dollar decrease in

tax liability.


Tax Credits• Hope Scholarship Credit

• Lifetime Learning Credit

• Earned Income Credit

• Child Tax Credit

• Child and Dependent Care Credit

• Retirement Savings Contribution Credit


Tax Liability

• Calculate the balance due the IRS or the amount of your refund.


Avoid Taxes Through Proper Planning

• Practice legal tax avoidance, not tax evasion.


Avoid Taxes Through Proper Planning

• A dollar saved from taxes is really two dollars - or more.

• Opportunity cost

• Earning another dollar to replace one given to the IRS

• Earnings on a dollar not given to the IRS


Reduce Taxable Income Via Your Employer

• Premium only plan

• Transportation reimbursement plan


Dependent Care Flexible Spending Account

• Flexible Spending Account (or FSA or Expense Reimbursement Account)


Defined-Contribution Retirement Plan

• Defined Contribution Retirement Plan– 401(k) Retirement Plan

• Matching Contributions


Make Tax-Sheltered Investments.

• Tax-Sheltered Investments: Investments that yield returns that are tax advantaged.


Reducing Taxable Income: Other Strategies

• Investing with pretax income

• Tax-deferred investment growth

• IRA

• Roth IRA



• Coverdell Education Savings Account

• Qualified Tuition (Section 529) programs

• Govt. savings bonds

• Municipal bonds



• Postpone income.

• Bunch deductions.

• Take all of your legal tax deductions.


Top 3 Financial Missteps in Managing Income Taxes

People slip up in building and maintaining good credit when they do the following:

1. Turn all you income tax planning over to someone else.

2. Overwithhold too much income to receive a refund next year.

3. Ignore the impact of income taxes in you personal financial planning.


Good Money Habits in Managing Income Taxes

• Reduce you income taxes by signing up for tax-advantaged employee benefits at your workplace.

• Contribute to you employer-sponsored 401(k) retirement plan at least up to the amount of the employer’s matching contribution.


Good Money Habits in Managing Income Taxes

• Buy a home to reduce income taxes.

• Do your own tax return so you can learn how to reduce your income tax liability.

• Maintain good tax records.

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