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Chapter 4 Lecture 1

Chapter 4 Lecture 1. Tax Planning and Strategies. Why Understand Taxes?. Knowledge of the tax laws can help you: Conserve income. Maximize deductions. Enhance investments. Protect transfer of wealth when you die. Sources of Federal Tax Law. US Constitution.

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Chapter 4 Lecture 1

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  1. Chapter 4Lecture 1 Tax Planning and Strategies

  2. Why Understand Taxes? • Knowledge of the tax laws can help you: • Conserve income. • Maximize deductions. • Enhance investments. • Protect transfer of wealth when you die.

  3. Sources of Federal Tax Law • US Constitution. • Statutory (legislative branch). • The Internal Revenue Code. • Administrative (executive branch). • The Treasury Dept. – the IRS is a division of the Treasury Dept. • Court decisions (judicial branch).

  4. Beginning of the Tax System • In 1913, the 16th Amendment gave Congress the right to impose the first income tax. • The IRC: Title 26 of USC (1939, 1954, 1986).

  5. Federal Tax Legislative Process (statutory) • House Ways and Means Committee. • Voted by the House. • Senate Finance Committee. • Voted by the Senate. • Joint Conference Committee reconciles. • Revised bill voted by the House and Senate. • Signed by the President. • Incorporated into the IRC.

  6. The Executive Branch • Treasury Department – administers the tax law. • Internal Revenue Service (IRS) is a division of the Treasury Department. • The IRS explains and enforces the tax law. • The Internal Revenue Code gives the IRS general authority to issue binding rules and regulations.

  7. The Judicial Branch • Courts interpret the law. • Disputes between the IRS and taxpayers may be settled in the federal courts. • A federal court will issue an opinion about the proper interpretation or application of a tax law.

  8. Federal Income Tax Structure • Progressive (or graduated) tax. • Increased income is taxed at increasing rates. • Tax brackets.

  9. Importance of Tax Planning • Taxes are your largest annual expense. • The average American spends over a quarter of each year earning money just to pay taxes. • Make sure you don’t overpay taxes.

  10. Income Tax Structure • Income tax is progressive, meaning that the more you earn, the higher the tax rate. • Tax brackets -- are income ranges for which the same marginal tax rate applies • 2006 SingleJoint • 10% $ 7,550 $ 15,100 • 15% $ 30,650 $ 61,300 • 25% $ 74,200 $123,700 • 28% $154,800 $188,450 • 33% $336,550 $336,550 • 35% over over

  11. Marginal vs. Average Rates • Marginal tax rate – looks at the percent of the next dollar you earn that will go toward taxes. • Average tax rate – relates taxes to taxable income or overall income. • The average amount of your total income taken away in taxes.

  12. Effective Marginal Tax Rate • Income-based taxes you pay: • Federal. • State. • City or local. • Social Security. • Effective marginal tax rate – the rate you pay when all income tax rates are combined.

  13. Capital Gains and Losses • Capital gain – what you make if you sell a capital asset for a profit. • Capital loss – what you lose when you sell a capital asset for a loss. • Capital asset – includes almost any asset you own, except for certain business assets.

  14. Capital Gains Tax • Short-term capital gain (assets held 12 months or less) – taxed based on your marginal tax rate. • Long-term capital gain (assets held for longer than 12 months) – 15% maximum tax rate.

  15. Capital Gains Income vs. Ordinary Income • Capital gains income is preferable to ordinary income. • The maximum tax rate on long-term capital gains is lower than the ordinary tax rate. • You have the ability to postpone capital gain tax liability (by not selling the asset).

  16. Other Income • Dividend income – paid on shares of stock or mutual funds. • Interest income – earned from savings accounts, from debt securities (e.g., bonds), and from loans.

  17. Filing Status • Single. • Married filing jointly and surviving spouses. • Married filing separately. • Head of household.

  18. Paying Your Income Taxes • Taxes are collected on a pay-as-you-go basis. • Most taxes are collected through withholding from wages. • Form W-4.

  19. FICA • Social Security – a mandatory insurance program administered by the government • Death, disability, health problems, or retirement. • Medicare – a government health care insurance program.

  20. FICA Tax Rates • FICA tax rate -- 15.3%. • 12.4 % for Social Security. • 2.9 % for Medicare. • FICA tax deducted from your salary – 7.65%. • 6.2% for Social Security. • 1.45% for Medicare. • Self-employed – you pay the whole tax. • Social Security cap, adjusted annually for inflation, is $94,200 in 2006. • No cap on Medicare (all earnings are subject to the tax).

  21. State and Local Income Taxes • Most states impose an income tax; however, some, like TX, FL, and WY, do not. • Local income taxes are uncommon; but some larger cities, for example, NYC, impose such a tax.

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