Chapter 4: Managing Taxes

1. Chapter 4: Managing Taxes

2. Explain how taxes are administered and classified. Describe the concept of the marginal tax rate. Determine who should file an income tax return. Objectives

3. 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. Objectives

4. 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

6. 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.

7. New Math

8. 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.

9. 3 Steps in Determining Taxes • Determining Adjusted Gross Income • Computing Taxable Income • Calculating Taxes Owed

12. Reduction Deferment Elimination What is Tax Management? • ATTENTION! • A PLANNING PROCESS FOR TAX:

13. Administration/Classification of Income Taxes • Federal tax laws • Progressive nature of income tax • Regressive • Marginal tax rate • Effective marginal tax rate • Average tax rate

14. 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

15. 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)

16. 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

17. 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% • Remaining $16,700 of income is taxed at 25% • Next $25,600 of income is taxed at 15% • 0 + 0 + $835.00 + $3,840.00 + $4,175 • Gross Income = $60,000 • Taxes = $8,850 • Marginal Tax Rate = 25%

18. 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%

19. 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%

20. How We Pay Taxes

21. Eight Steps in Calculating Your Income Taxes • Step 1 • Total Income • Subtract exclusions • Step 2 • Gross Income • Subtract adjustments to income. • Step 3 • Adjusted Gross Income • Subtract standard deduction or total itemized deductions. • Step 4 • Subtotal • Step 5 • Taxable Income • Subtract value of exemptions • Apply tax table or tax-rate schedule to determine liability. • Step 6 • Step 7 • Final tax liability • Subtract tax credits • Calculate balance owed or refund. • Step 8

23. 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)

24. 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.

25. The Progressive Nature of the Federal Income Tax-2010 • 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.

27. 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%

28. Who Should File a Tax Return? • Earned income • Unearned income • Transfer payments • STUDENTS WITH:

37. Is it Taxable Income? Is it Deductible?