Chapter 4: Managing Taxes
Objectives
• Explain how taxes are administered and classified.
• Describe the concept of the marginal tax rate.
• Determine who should file an income tax return.
Objectives
• Describe the two ways of paying taxes: payroll withholding and estimated taxes.
• Identify the three steps involved in calculating federal income taxes.
• Understand planning strategies to legally avoid overpayment of income taxes.
• Explain the basics of IRS audits.
Taxes on Purchases
State and local taxes are added to the purchase price of goods.
Excise tax is imposed on specific goods and services• Gasoline• Cigarettes• Alcohol• Tires• Air travel• Telephone service
Taxes on Property
Real estate property tax is based on the value of land and buildings.
Personal property taxes on the value of automobiles, boats, furniture, and farm equipment are imposed in some areas.
New Math
Taxes on Wealth
Estate tax-federal tax imposed on the value of an individual’s property at the time of death.
Inheritance tax-state tax levied on the value of property bequeathed by a deceased individual.
3 Steps in Determining Taxes
1. Determining Adjusted Gross Income
2. Computing Taxable Income
3. Calculating Taxes Owed
What is Tax Management?
• Reduction
• Deferment
• Elimination
ATTENTION!
A PLANNING PROCESS FOR TAX:
• Federal tax laws
• Progressive nature of income tax
• Regressive
• Marginal tax rate
• Effective marginal tax rate
• Average tax rate
Administration/Classification of Income Taxes
Step 1: Determining Adjusted Gross Income (AGI)
Earned Income-money received by personal effort.
Investment Income-money received in the form of dividends, interest, or rent
Passive Income-activities in which you do not actively participate.
Other Income-Alimony, awards, lottery winning, prizes
Other Items That Impact Income
Exclusion-amount not included in gross income.
Tax Exempt Income-another name for exclusions-Qualified scholarships and fellowships where money is used for tuition, fees, supplies, and equipment, VA payments
Tax Deferred Income-income that will be taxed at a later date
Adjusted Gross Income (AGI)-gross income after certain reductions have been made
Tax Shelters-immediate tax benefits and a reasonable expectation of a future financial return (IRA’s Keogh’s)
Taxes on Earnings
Social Security 7.65%
Income Tax• Federal tax• State tax in all but 7 states
• Alaska• Florida• Nevada• South Dakota• Texas• Washington• Wyoming
The Marginal Tax Rate Affects Your Final Decision
$3,650 personal exemption is not taxed
$5,700 standard deduction is not taxed
Next $8,350 of income is taxed at 10%
Next $25,600 of income is taxed at 15%
Remaining $16,700 of income is taxed at 25%
0 + 0 + $835.00 + $3,840.00 + $4,175
Gross Income = $60,000Taxes = $8,850Marginal Tax Rate = 25%
State, Local and Total Income Tax Bracket
Total Income Tax Bracket =
Federal + State – (Federal x State)
Mike’s federal tax bracket is 28% and his state income tax bracket is 7
percent. His total income tax bracket is:
28% + 7% - (28% x 7%)
=.35 -.02
= .33 or 33%
Adjusting Interest Rates
After Tax Interest Rate =
Interest Rate x (1- Marginal Tax Rate)
If you pay 10% interest on a $1,000 loan your interest payment is $100. But if that interest is deductible and you’re in the 28% tax bracket, you save 28% of $100 or $28 in taxes. So, counting your tax savings, you’ve paid only $72 in after tax interest or 7.2% of $1,000.
.10 x (1-.28)
= .10 x .72
=.072 or 7.2%
How We Pay Taxes
Eight Steps in Calculating Your Income Taxes
Step 1 Total Income
Subtract exclusions
Step 2
Subtract adjustments to income.
Step 3
Subtract standard deduction or total itemized deductions.
Step 4
Gross Income
Adjusted Gross Income
Subtotal
Taxable Income Subtract value of exemptionsStep 5
Apply tax table or tax-rate schedule to determine liability.
Step 6
Final tax liability Subtract tax creditsStep 7
Calculate balance owed or refund.
Step 8
Step 2: Computing Taxable Income
Deduction-an amount subtracted from AGI to arrive at taxable income.
• Standard deduction ($5,700/single in 2010)
• Itemized deduction
Exemption-a deduction from AGI for yourself, your spouse, and qualified dependents ($3,650 in 2010)
Step 3: Calculating Taxes Owed
Use your taxable income in conjunction with the appropriate tax table or tax schedule.
Marginal tax rate-the tax on the last dollar of income.
Average tax rate-total tax due divided ty your taxable income.
Tax credit-amounts subtracted from the amount of tax owed.
The Progressive Nature of the Federal Income Tax-2010
If your taxable income is:Over:
But notover -- The tax is:
Of theamountover--
$0 $8,350 ------------ 10% $0
8,350 33,950 $835.00 + 15% 8,350
33,950 82,250 4,675.00 + 25% 33,950
82,250 171,550 16,750.00+ 28% 82,250
171,550 372,950 41,754 + 33% 171,550
372,9650 ---------- 108,216 + 35% 372,950
If your filing status is Single
The Tax Rate Schedule is shown so you can see the tax rate that applies to all levels of taxable income. It is not used to figure ones’ taxes.
Tax Credit Versus Tax Deduction
$100 tax credit reduces your taxes by $100
$100 tax deduction reduces taxes by your tax bracket. For instance, if a person is in the 25% tax bracket it would reduce your taxes by 25%
• Earned income
• Unearned income
• Transfer payments
Who Should File a Tax Return?
STUDENTS WITH:
Is it Taxable Income? Is it Deductible?
Is it Taxable Income? Yes No
Lottery Winnings
Child Support Received
Worker’s Compensation Benefits
Life Insurance Death Benefits
Municipal Bond Interest Earnings
Bartering Income
Is it Deductible? Yes No
Life Insurance Premiums
Cosmetic Surgery for Improved Looks
Fees for Traffic Violations
Mileage for Driving to Volunteer Work
An Attorney’s Fee for Preparing Will
Income Tax Preparation
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