Presentation on theme: "Prentice-Hall, Inc.1 Chapter 4 Tax Planning and Strategies."— Presentation transcript:
Prentice-Hall, Inc.1 Chapter 4 Tax Planning and Strategies
Prentice-Hall, Inc.2 How It All Began In 1913, the 16th Amendment gave Congress the right to impose the first income tax Initial tax rates ranged from 1 to 8%
Prentice-Hall, Inc.3 Importance of Tax Planning Taxes are your largest annual expense The average American works more than 4 months just to pay his/hers taxes
Prentice-Hall, Inc.4 Income Tax Structure Income tax -- progressive tax meaning that the more you earn the more you pay Tax brackets -- income ranges for which the same marginal tax rate applies Marginal tax rate -- percentage of the last dollar that you earned that will go toward federal income taxes
Prentice-Hall, Inc.5 Income Tax Structure (cont’d) Average tax rate -- average amount of every dollar you earned that was paid for federal income taxes Effective marginal tax rate -- average amount of every dollar you earned that paid for all local, state, and federal income taxes
Prentice-Hall, Inc.6 Capital Gains Taxes and the Taxpayer Relief Act of 1997 Capital gains tax -- can be postponed until you sell an asset for a profit Short-term capital gains -- gains made from assets held less than 12 months Long-term capital gains -- gains made from assets held for 12 months or longer
Prentice-Hall, Inc.7 Tax Rates Associated With Capital Gains These rates are dependent on how long the asset is held as well as the marginal tax bracket of the owner. Short-term rate – 28% Long-term rate – 20%, unless you’re in the 15% tax bracket and then it is 10%
Prentice-Hall, Inc.8 Tax Rates Associated With Capital Gains After 2000 Applies to assets purchased in or after 2001and held for 5 years Long-term rate of 18%, unless you’re in the 15% tax bracket and then it is 8%
Prentice-Hall, Inc.9 What Does This Mean For You? Avoid frequent trading Buy low-turnover, “tax managed” mutual funds Buy individual stocks and make your own mutual fund
Prentice-Hall, Inc.10 Capital Gains Taxes On Homes Gains up to $500,000 for couples and $250,000 for individuals exempt from taxes Home must be your principal residence Must have lived there 2 of the last 5 years No need to “rollover gain” as before the Taxpayer Relief Act of 1997
Prentice-Hall, Inc.11 Filing Status Classifications Single Married filing jointly Married filing separately Head of household
Prentice-Hall, Inc.12 Cost of Living Increases in the Tax Brackets The tax brackets change annually to insure that no one pays more income tax just because earnings increased with inflation. Bracket creep -- a tax liability increase caused by inflation. Example -- the income minimum for the 28% tax bracket for joint filers increased from $42,350 to $43,050 in 1999.
Prentice-Hall, Inc.13 Paying Your Income Taxes Withholdings -- tax payment from each paycheck, determined on the basis if income and W-4 form Quarterly estimated payments Payments with the tax return (the dreaded April 15th) Withholdings from stock, retirement funds, and prize or gambling winnings
Prentice-Hall, Inc.14 Social Security or FICA Social Security -- a mandatory insurance program administered by the federal government that provides support in the event of death, disability, health problems, or retirement. Tax rate of 6.20% of gross salary Social Security cap, adjusted annually for inflation, was $72,600 in 1999. Income over this amount is not taxed.
Prentice-Hall, Inc.15 Social Security or FICA (cont’d) Medicare -- a health care insurance program for elderly and disabled. Tax rate of 1.45% of gross salary, with no annual cap. Total FICA tax rate -- 15.3% (12.4% Social Security + 2.9% Medicare). You are only responsible for half of the tax unless you’re self-employed.
Prentice-Hall, Inc.16 State and Local Income Taxes Most states impose an income tax; however, some, like Texas, do not. Local income taxes are uncommon; but some larger cities, for example, New York City, impose such a tax.
Prentice-Hall, Inc.17 Other Non-Income-Based Taxes That You Face Excise “sin taxes” and state sales taxes -- imposed when goods are purchased Real estate and property taxes -- imposed annually or semi-annually on assets owned Gift and estate taxes -- imposed when assets are transferred from one owner to another
Prentice-Hall, Inc.18 Calculating Your Taxes Who has to file an income tax return? Determining gross or total income Calculating adjusted gross income (AGI) Subtracting deductions Claiming your exemptions Calculating your base income tax Determining your credits Determining your final tax liability
Prentice-Hall, Inc.19 Who Has to File an Income Tax Return? Everyone who earns more than $14,400 must file an income tax return. Some people who earn less, depending on age, filing status, and dependency status must file a return. People who have more than $700 of unearned income must file. Note: All thresholds are for 1999 and are adjusted annually for inflation.
Prentice-Hall, Inc.20 Sources of Taxable Income Wages, salaries, and tips Capital gains, dividends, and interest Alimony Pension funds and IRA distributions Business and farm income Rental and royalty income Social Security and unemployment benefits
Prentice-Hall, Inc.21 Sources of Tax-Exempt Income Roth IRA earnings State and local municipal bond interest Gifts and inheritances Child support payments Federal income tax refunds Veterans’ and welfare benefits
Prentice-Hall, Inc.22 Subtracting Adjustments to Calculate AGI – Alimony payments – Selected moving expenses – Selected IRA and other retirement contributions – 50% for Social Security and Medicare (self-employed only) – Penalties for early withdrawal – Student loan interest, with limitations
Prentice-Hall, Inc.23 Subtracting Deductions from AGI Itemized deductions (Normally, you must first own a home.) Standard deductions
Prentice-Hall, Inc.24 IRS Limits on Itemized Deductions Medical and dental expenses -- must exceed 7.5% of AGI Selected tax expenses Home mortgage and investment interest payments Gifts to charity -- Keep good records, but must have receipt if the gift is more than $250
Prentice-Hall, Inc.25 IRS Limits on Itemized Deductions (cont’d) Casualty and theft loss -- first $100 of loss is excluded, and remaining losses are deductible only to the extent they exceed 10% of AGI. Miscellaneous deductibles -- must exceed 2% of AGI. Percentage of itemized deductions lost for filers above a certain income level.
Prentice-Hall, Inc.26 Standard Deductions Single -- $4,300 (1999) Married filling jointly -- $7,200 (1999) Head of household -- $6,350 (1999) Married filing separately -- $3,600 (1999) Note: thresholds are indexed to inflation
Prentice-Hall, Inc.27 Using Standard or Itemized?? Take the larger of the two amounts If close, consider bunching deductions Don’t let laziness or poor recordkeeping cost you money!
Prentice-Hall, Inc.28 Additional Deductions for Elderly or Blind Taxpayers Unmarried taxpayer -- $1,050 ($2,100 if both elderly and blind). Married taxpayer -- $850 ($1,700 if both elderly and blind). Amounts shown are for 1999 and are adjusted annually for inflation.
Prentice-Hall, Inc.29 Claiming Your Exemptions Exemptions are meant to provide everyone with some untaxed income, provided you don’t earn too much. Personal exemptions -- $2,750 (1999). Dependency exemptions – Three-step dependency test Exemption phaseout.
Prentice-Hall, Inc.30 Calculating Your Base Income Tax on Taxable Income Tax tables in the booklet. Tax rate schedules -- must be used if income exceeds $100,000. Alternative minimum tax -- to prevent the very wealthy from using the tax breaks to pay little or no tax.
Prentice-Hall, Inc.31 Determining Your Credits Child credit Hope Scholarship credit Lifetime Learning credit Child and dependent care credit Earned income credit (EIC) Adoption credit Other credits, such as elderly and disabled taxpayer credits
Prentice-Hall, Inc.32 Other Filing Considerations Picking the right form Determining how to file Filing late or amended returns Where to get help
Prentice-Hall, Inc.33 Choosing a Tax Form 1040EZ – taxable income less than $50,000 – can’t itemize or claim dependents 1040A – taxable income less than $50,000 – allows for more sources of income
Prentice-Hall, Inc.34 Choosing a Tax Form (cont’d) 1040 “long form” – allows the use of schedules – only form that allows you to itemize deductions Know the schedules
Prentice-Hall, Inc.35 How To File? Electronic Filing –Refund within 3 weeks –Less chance of processing error –Cost? Filing by mail
Prentice-Hall, Inc.36 Filing Late and Amended Returns Filing late – Form 4868 – Penalties -- 10% of tax bill Amended returns – Form 1040X – Limitations -- 3 years after the original tax due date
Prentice-Hall, Inc.37 Reasons for Being Audited Random Previous errors High income level Filing a Schedule C Audits allow the IRS to conduct spot checks of returns to ensure compliance to the tax laws and regulations
Prentice-Hall, Inc.38 Preparing for an Audit Reexamine the areas in question Gather all supporting data Anticipate any probable questions Hire a tax accountant or attorney (if necessary) Note: the best way to win an audit is to keep excellent records
Prentice-Hall, Inc.39 Appealing an Audit Outcome Appeal with the auditor Appeal with the auditor’s manager File a formal appeal Go to tax court
Prentice-Hall, Inc.40 Help in Preparing Your Taxes IRS Publication 17 IRS hotline Self-help tax publications Computer programs Videos Tax specialists--be sure to start early
Prentice-Hall, Inc.41 Tax Planning to Minimize Payments Maximize your deductions. Look to capital gains income in particular if you are in the top tax brackets. Receive tax-exempt income such as income for municipal bonds. Defer taxes to the future.
Prentice-Hall, Inc.42 Maximizing Your Deductions Using tax-deferred retirement programs to reduce taxes. Using your home as a tax shelter. Shifting and bunching your deductions.
Prentice-Hall, Inc.43 Look to Capital Gains Income Long-term capital gains rates are taxed less than your earned income. In some cases as much as 19.6% less. Taxes are postponed until the assets are sold.
Prentice-Hall, Inc.44 Shift Income to Family in Lower Tax Brackets Gifts -- $10,000 per person ($20,000 per couple) per year tax-free. Trusts -- hold property for another.
Prentice-Hall, Inc.45 Receive Tax-Exempt Income Municipal bond interest from state and local government debt. The higher your marginal tax bracket, the more beneficial tax-free income is.
Prentice-Hall, Inc.46 Defer Taxes to the Future Traditional IRAs,401(k) plans, and Keogh plans defer taxes to the future. Roth IRA earnings are never taxed. Long-term capital gains taxes are not paid until the asset is sold.
Prentice-Hall, Inc.47 Summary Know the U.S. tax code and your marginal tax bracket -- use both for tax planning to minimize tax payments. Use adjustments, exemptions, and deductions to calculate your taxable income. Use credits to reduce your tax liability.
Prentice-Hall, Inc.48 Summary (cont’d) Know who must file, how, and when. Know how and where to get help filing. Know how to prepare for an audit.
Prentice-Hall, Inc.49 Summary (cont’d) Know how to use tax strategies to reduce your tax liability – maximize deductions – look to capital gains income – shift income – look to tax-exempt income – defer taxes