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Taxes in Your Financial Plan

3. Taxes in Your Financial Plan. Taxes in Your Financial Plan. Chapter Objectives. Identify the major taxes paid by people in our society Calculate taxable income and the amount owed for federal income tax Prepare a federal income tax return

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Taxes in Your Financial Plan

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  1. 3 Taxes in Your Financial Plan

  2. Taxes in Your Financial Plan Chapter Objectives • Identify the major taxes paid by people in our society • Calculate taxable income and the amount owed for federal income tax • Prepare a federal income tax return • Select appropriate tax strategies for various life situation

  3. Objective 1: Identify the major taxes paid by people in our society Planning your Tax strategy • In order to start planning for taxes, you should…. • Know current tax laws as they affect you. • Maintain complete and appropriate tax records. • Make purchase and investment decisions that reduce your tax liability. Your tax planning should be targeted toward paying your fair share but still taking advantage of tax benefits.

  4. Types of Taxes • Taxes on Purchases. • Sales tax & excise tax. • Taxes on Property. • Real estate property tax. • Personal property tax. • Taxes on Wealth. • Federal estate tax. • State inheritance tax. • Taxes on Earnings. • Income tax.

  5. What Tax Records to Keep • Current tax forms and instruction booklets. • Social security numbers. • Copy of previous year’s returns. • W-2 forms from employers. • 1099 forms (interest, self employment). • 1098 (mortgage interest paid). • Receipts and documentation for expenses. • Investment & business expense documents.

  6. Objective 2: Calculate taxable income and the amount owed for federal income tax • Step 1:Determining adjusted gross income. • First identify taxable income - the net income, after deductions, on which income tax is computed. Types of income subject to taxation include… • Earned income which usually include wages, salary, commissions, fees, tips or bonuses. • Investment income is money received in the form of dividends, interest or rent from investments. • Passive income results from business activities in which you do not directly participate such as a limited partnership. • Alimony, awards, lottery winnings and prizes.

  7. Objective 2: Calculate taxable income (continued) • Total income is affected by Exclusions. • Exclusions are amounts not included in gross income. • Exclusions are also referred to as tax-exempt income, which is income not subject to federal income tax. An example is interest on most state and city bonds. • Total income is also affected by tax-deferred income. This is income that will be taxed at a later date, such as earnings from an traditional individual retirement account (IRA).

  8. Objective 2: Calculate taxable income (continued) • Adjusted gross income is is gross income after certain reductions have been made. These reductions are called adjustments to income, and include the following. • Contributions to a traditional IRA or Keogh. • Alimony payments. • Tax-deferred retirement plans, such as a 401(k)or a 403(b)(7) are a type of tax shelter. • Tax shelters are investments that provide immediate tax benefits and a reasonable expectation of a future financial return.

  9. Objective 2: Calculate taxable income (continued) • Step 2:Computing Taxable Income. • A tax deduction is an amount subtracted from adjusted gross income (AGI) to arrive at taxable income. • You can subtract the standard deduction from AGI or itemize your deductions; • Itemized deductions can include items such as... • Medical and dental expenses >7.5% of AGI. • Taxes, interest, contributions and theft loses. • Moving, job-related, and miscellaneous expenses.

  10. Objective 2: Calculate taxable income (continued) • Next subtract exemptions from AGI. • An exemption is a deduction for yourself, your spouse and qualified dependents. • The amount of the exemption for the 0000 tax year was 0000 per person but this amount increases slightly each year. • After deducting exemptions you have your taxable income.

  11. Objective 2: Calculate taxable income (continued) • Step 3: Calculating taxes owed. • The percent rates are the marginal tax rates on the last dollars of taxable income. • For example, after deductions and exemptions, a person in the 28% tax bracket pays 28 cents in taxes for every dollar of taxable income in that bracket.

  12. Objective 2: Calculate taxable income (continued) A person’s average tax rate is based on the total tax due divided by taxable income. This rate is less than a person’s marginal tax rate. • For example, if a person with a taxable income of $40,000 has a total tax bill of $4,200, their average tax rate is 10.5%.($42,000/$4,200) Alternative minimum tax is paid by taxpayers with high amounts of certain deductions and various types of income Designed to make sure that those who receive tax breaks also pay their fair share of taxes Subtract tax credits. A tax credit is an amount subtracted directly from the amount of taxes owed, such as the earned income or child and dependent care credits.

  13. $100 Tax Credit Reduces Your Taxes by $100 $100 Tax Deduction Amount Your Taxes are Reduced is Based on Your Tax Bracket Tax Credit versus Tax Deduction

  14. Objective 2: Calculate taxable income (continued) Step 4:Making Tax Payment You pay federal income taxes through either payroll withholding or estimated tax payments Withholding Based on the number of exemptions and the expected deductions claimed Estimated Payments Estimated tax payments made throughout the year based on income made during the year and reported on Form 1099.

  15. Determine tax withheld 3-16 Making Tax Payment W-2 Form

  16. Objective 2: Calculate taxable income (continued) Step 5:Watching Deadlines and Avoiding Penalties • Use Form 4868 to obtain an automatic four-month extension • Submit the estimated amount along with Form 4868 by April 15 • Underpayment of quarterly estimated taxes may require paying interest on the amount owed • Underpayment due to negligence can result in penalties of 50 to 75 percent

  17. Objective 3: Prepare a Federal Income Tax Return Every citizen or resident of U.S. and every U.S. citizen who is a resident of Puerto Rico is required to file income tax • There are five filing status categories. • Single or legally separated. • Married, filing jointly. • Married, filing separately. • Head of household. • Unmarried individual or surviving spouse who maintains a household for a child or dependent relative. • Qualifying widow or widower (2 years).

  18. Which Tax Form Should You Use? • There are about 400 federal tax forms and schedules. • Basically the choice is between 3 forms 1040EZ 1040A 1040 • Which form to use depends on • Type of income • The amount of income • The number of deductions • Complexity of tax situation

  19. Process for Completing Federal Income Tax Return • In summary the steps to completing your return include: • Filing status and exemptions. • Income. • Adjustments to income. • Tax computation. • Tax credits. • Other taxes (such as from self-employment) • Payments (total withholding and other payments).

  20. Process for Completing Federal Income Tax Return cont’d… • Refund or amount you owe • Refunds can be sent directly to your bank account. • Your signature • Most common filing error

  21. How do I File my State Tax Return? • All but seven states have a state income tax • Most states tax rate ranges from 1 to 10 percent • States usually require income tax returns to be filed when the federal income tax return is due

  22. How do I file My Taxes Online? • Software packages like TaxCut and TurboTax allow you to complete the needed tax forms • You can print and mail the forms or file online • With e-filing refunds usually take 3 weeks • Over 60 million returns are filed electronically last year • Cost for the service is between $15-$40

  23. Available Tax Assistance Sources • IRS Services. • Publications and forms 1-800-TAX-FORM. • www.irs.gov • Recorded messages 1-800-829-4477. • Phone hot line 1-800-829-1040. • Walk-in service at an IRS office. • CD-ROM the IRS sells that has forms and pubs. • Tax publications e.g. Ernst and Young Tax Guide and J.K. Lasser’s Your Income Tax • The Internet. • Tax preparation software companies.

  24. Available Tax Assistance Sources (continued) • Tax Preparation Software. • TurboTax and TaxCut are two of the most popular tax preparation software • Using software can save 10 or more hours • Tax Preparation Services • Tax preparers charge between $40 and $2000 depending on the complexity of the return • Over 40 million U.S. taxpayers pay someone else to do their taxes

  25. Available Tax Assistance Sources (continued) • Types of Tax Services • Range from a one-person office to large firms such as H & R Block. • Government-approved tax experts are called enrolled agents. • CPA Tax Accountants. • Attorneys. • If your professional tax preparer makes a mistake, you are still responsible for paying the correct amount, plus any interest and penalties.

  26. Evaluating Tax Services Factors to consider when evaluating tax services • Training and experience of the tax professional • Fee for preparing taxes • Questionable deductions • If return is audited will the preparer represent the client? • Is tax preparation the main business activity or is it a front for other financial products

  27. Tax Service Warnings • Ultimately you are responsible for providing complete and accurate information • Hiring a tax preparer does not guarantee that you will pay the correct amount • Beware of tax preparers that offer refunds in advance • “Refund anticipation loans” can charge interest rates in excess of 300%

  28. What if Your Return is Audited? About 0.6% of all returns are audited. If you claim large or unusual deductions you are more likely to be audited. • There are three types of audits. • Correspondence audit for minor questions. • Office audit takes place at an IRS office. • Field audit is the most complex, with an IRS agent visiting you at your home, your business or your accountant’s office. Your Audit Rights • You have audit rights, including time to prepare for the audit, and clarification.

  29. Objective 4: Select appropriate tax strategies for various life situations Tax Planning Strategies • Practice tax avoidance. • Legitimate methods to reduce your tax obligation to your fair share but no more. • Financial decisions related to purchasing, investing, and retirement planning are the most heavily affected by tax laws. • Tax Evasion. • Illegally not paying all thetaxes you owe, such as not reporting all income.

  30. Tax-Planning Strategies (continued) • To minimize taxes owed... • If you expect to have the same or a lower tax rate next year, accelerate deductions into the current year. • If you expect to have a lower or the same tax rate next year, delay the receipt of income until next year. • If you expect to have a higher tax rate next year, delay deductions since they will have a greater benefit. • If you expect to have a higher tax rate next year, accelerate the receipt of income to have it taxed at the current lower rate.

  31. Tax-Planning Strategies (continued) Consumer Purchasing • Owning a home is one of the best tax shelters because you can deduct mortgage loan interest and property taxes when you itemize. This reduces your taxable income. • Use your home equity line of credit to buy a car or consolidate debt, since the interest you pay can be deducted when you itemize. • Job-related expenses may be allowed as itemized deductions. • Health care expenses like FSA’s (Flex Spending Accounts) allow you to reduce your taxable income when paying for health related expenses

  32. Tax-Planning Strategies contd…. Investment Decisions TAX EXEMPT INVESTMENTS Using tax-exempt investments, such as municipal bonds can help reduce your taxes. TAX DEFERRED INVESTMENTS • Tax deferred annuities • Section 529 savings plans • Retirement Plans Capital Gains • Long-term capital gains taxed at a lower rate. • Held more than one year.

  33. Tax-Planning Strategies contd…. (continued) Investment Decisions contd… SELF EMPLOYMENT Owning your owning business can have tax advantages Business owners have to pay additional taxes CHILDREN’S INVESTMENT Children under 14 with investment income of more than $1500 are taxed at parent’s top rate Retirement Plans TRADITIONAL IRA ROTH IRA EDUCATION IRA KEOGH PLAN 401 (K) PLAN

  34. Changing Tax Strategies (continued) • IRS modifies tax filing procedures, and Congress passes legislation to change the tax code each year. • You should take advantage of these changes for personal financial planning • Consider changes in your personal situation and income • Monitor your tax strategies to best serve your daily needs and long-term financial goals

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