Chapter 4

© Winger & Frasca, Personal Finance: An Integrated Planning Approach, 6th Ed., Prentice Hall Inc.

Personal Finance:Personal Finance:An Integrated Planning ApproachAn Integrated Planning Approach

Winger & FrascaWinger & Frasca

Chapter 4Chapter 4TaxesTaxes

http://www.prenhall.com/winger/


Major TopicsMajor Topics

Determining Your Federal Income Tax Other Aspects of the Federal Income Tax Planning to Reduce Your Income Taxes


Figure 4.2 Federal Income Tax FormulaFigure 4.2 Federal Income Tax FormulaGlobal Income

Less Nontaxable Exclusions

Gross Income

{

Adjustments to Gross Income{Adjusted Gross Income

{ Less personal and dependency deductionsLess itemized or standard deductions

Taxable Income

{


Figure 4.2 Federal Income Tax FormulaFigure 4.2 Federal Income Tax FormulaTaxable Income

Taxes Before Credits and Other Taxes

{ Determine taxes based upon taxable income and family status

Less tax credits plus other taxes

{

Taxes Before Credits and Other Taxes

Tax Refund or Taxes Due

Less taxes withheld and estimated taxes paid

{


Gross IncomeGross Income

Sources of income that are subject to the federal income tax

Primary Sourceswages and salaries alimony interest

capital gains dividends pensions

business income rentals royalties

partnerships


Adjusted Gross IncomeAdjusted Gross Income

Gross income plus or minus

certain adjustments

Examples of possible exclusions

IRA contributions Moving expenses

Alimony paid

Self-employed health insurance

One-half of self-employment tax


Taxable IncomeTaxable Income

equalsequals

Adjusted gross income less – personal and dependency exemptions– personal deductible expenses


Taxable IncomeTaxable Income

Personal and dependency exemptions – Each spouse on a joint return – Any of the taxpayer’s dependents– $2,900 for each dependent in 2001


Standard Deduction for 2001Standard Deduction for 2001

Filing Status Standard Deduction

Married filing jointly or Qualifying widow(er)

$7,650

Head of household $6,650

Single $4,550

Married filing separately $3,800


Typical Itemized DeductionsTypical Itemized Deductions

Medical expenses– in excess of 7.5% of adjusted gross income

State and local income taxes Personal property taxes


Typical Itemized DeductionsTypical Itemized Deductions

Interest on home mortgages (limitations) Charitable contributions (limitations) Casualty and theft losses (limitations) Miscellaneous business related expenses

– in excess of 2% of adjusted gross income


2001 Tax Rate Schedule2001 Tax Rate ScheduleSingle TaxpayersSingle Taxpayers


2001 Tax Rate Schedule2001 Tax Rate ScheduleJoint TaxpayersJoint Taxpayers


A direct deduction against your tax liability

Examples of possible credit– Credit for the elderly (include disability credit)– Earned income credit– Education tax credit– Child and dependent care expenses– Jobs credit

Tax CreditsTax Credits


Tax Rate MeasuresTax Rate Measures

Average tax rate– total tax liability divided by total income

Marginal tax rate– additional tax liability divided by additional

income– the tax rate on an incremental dollar of income


Capital Gains and LossesCapital Gains and Losses

Gain or loss resulting from the sale of a capital asset

Capital asset is an asset held for pleasure or investment

Capital gains and losses receive special tax treatment


Taxes on Capital GainsTaxes on Capital Gains

The holding period will determine the tax rate on capital gains– Gains or losses on a capital asset held less than one

year are “short-term” – Gains or losses on a capital asset held one year or

more are “long-term” Short-term gains or losses on

financial assets are treated like changes to ordinary income


Taxes on Capital GainsTaxes on Capital Gains

The maximum tax rate for the gain on most long-term financial assets will depend upon your marginal tax rate– The rate is 10% if you are in the 15% marginal

tax bracket and 20% if you are in a higher tax bracket

– This does not apply to collectibles which are taxed at a maximum rate of 28%


Tax Treatment on LossesTax Treatment on Losses

Capital losses on personal use assets are not deductible

Capital losses on financial assets may be deducted up to a $3,000 limit– Losses not deducted in the current year may be

carried forward to the next tax year


Selling Your HomeSelling Your Home

You can typically exclude from taxable income up to $250,000 ($500,000 if married) of the capital gain on the sale of your home

To get the full exclusion you must have owned the home for the last two years, and

used it as your main home for two recent years


Special Considerations for StudentsSpecial Considerations for Students

Scholarships and Fellowships Employment related advantages Education Tax Credits Other Special Advantages


Scholarships and FellowshipsScholarships and Fellowships

Awards that cover purely educational expenses that lead to a degree are most likely not taxable

Payments for noneducational expenses are taxable– subsistence allowances paid to ROTC students

in advanced training is an exception


Employment Related AdvantagesEmployment Related Advantages

A qualified tuition reduction– tuition reduction provided to employee or

relative of employee



Qualifying educational expenses– Must be required by employer to maintain or

improve the skills needed in your current job– Cannot be used to prepare you for the minimal

skills needed in your current position or prepare you for a new job

– Itemized deduction that must exceed 2% of your adjusted gross income



Qualified educational assistance– Includes educational expenses paid for by your

employer– Your employer can tell you which expenses are

qualified


Education Tax CreditsEducation Tax Credits

Hope Scholarship Credit– For first two years of postsecondary education– Must be enrolled at least half-time in a degree

program– Limit on maximum credit and phased out at

higher incomes


Education Tax CreditsEducation Tax Credits

Lifetime Learning Credit– May receive this credit in years you do not

qualify for the Hope Scholarship Credit– Limit on maximum credit and phased out at

higher incomes


Other Special Tax AdvantagesOther Special Tax Advantages

Temporary College Deduction Education IRA State and Private Tuition Programs Student Loan Interest Education Savings Bonds


Plan to Reduce Your TaxesPlan to Reduce Your Taxes

Invest where you receive tax-advantaged income

Take capital losses quickly Split your income Stagger income and expenses Defer income to later years


Sources of Tax-Advantaged IncomeSources of Tax-Advantaged Income

Municipal bonds – tax exempt interest earned

Home ownership– tax exempt interest paid– capital gains exemption

Real estate investments– depreciation– loss deductions


Defer Income to Later YearsDefer Income to Later Years

Pension plans Tax-deferred annuities US Treasury Series EE Bonds


Other Important TaxesOther Important Taxes

Social Security Taxes State and Local Taxes

– income taxes– property taxes– sales taxes

Estate and Gift Taxes– federal & state estate and gift taxes– state inheritance taxes


Death TaxesDeath Taxes

A tax on property either transferred or received at death

Estate tax– imposed on property of deceased before

transfer


Death TaxesDeath Taxes

Gift tax– on gifts transferred during life

Inheritance tax– paid by beneficiary on property received


Estate Tax ExemptionEstate Tax Exemption

Death in Top Rate Exemption

2002 2003 2004 2005 2007 2008 2009 2010

2011+

50% 49% 48% 46% 45% 45% 45%

Repealed 55%

$1 million $1 million

$1.5 million $2 million $2 million $2 million

$3.5 million

$1 million


Federal Income TaxesFederal Income Taxes

Let goods that have appreciated in market value transfer at death

Don’t bequeath property that has depreciated in value

Be aware of how ownership can affect tax liabilities


NextNextChapter 5Chapter 5

Cash ManagementCash Management

Chapter 4

Business

Transcript of Chapter 4