MBA620 05 tax planning 19sep07

Definitions continued• Allowable deductions if you itemize include charitable contributions cash, in kind, and/or mileage, home mortgage interest, medical expenses >7.5% AGI, un-reimburs

Personal Finance Another Perspective

Tax Planning

regarding taxes

and how it helps attain your personal goals

help lower your taxes (legally and honestly)

tax system

Your Personal Financial Plan

you use last year?

tax rates?

should you use this year?

reduce your tax bill to Uncle Sam?

A Understand our Leaders

Counsel on Taxes

that keepeth the laws of God hath no need to break the laws of the land Wherefore, be subject to the powers that be, until he reigns whose right it is to reign, and subdues all

enemies under his feet (D&C 58:21-22)

presidents, rulers, and magistrates, in

obeying, honoring, and sustaining the law.

Our Leaders Counsel (continued)

President Harold B Lee instructed:

• “There seem to be those among us who are as

wolves among the flock, trying to lead some who are weak and unwary, who are taking the law into their own hands by refusing to pay their

income tax.” (Ensign, January 1973, p 106.)

• In the April 1973 Priesthood Bulletin the Church

reaffirmed its position stating:

• “We ask priesthood leaders to be on guard against such persons Priesthood leaders should teach the necessity of abiding the law according to the revelations (Priesthood bulletin, April 1973)

have said about paying taxes?

B Understand How Tax Planning can

help attain your Personal Goals

months just to pay his or her taxes

you have for your personal and financial goals!

Tax Freedom Day

• Figure 1: Tax Freedom Day, 1980 – 2006

• Source: Tax Foundation, Washington, D.C.,

http://taxfoundation.org/UserFiles/Image/Tax-Freedom-Day/2006

The Impact of Taxes

Retirement

Cash ManagementGoals

Taxes

your personal goals?

C Understand the Tax Process and

Strategies to Reduce Taxes

4 Minus exemptions

= Taxable Income

5 Look up tax

on tax table = Tentative Tax

6 Minus credits

= Total Tax Owed

7 Minus taxes already paid = Balance Due or Amount of Refund

Definitions

• Total income for tax purposes is all income from whatever source, unless specifically excluded It also includes some losses, such as net capital losses (up to $3,000), sole proprietorship losses, and

active participation real estate losses

• Specifically excluded includes certain employer

provided fringe benefits, gifts and inheritances,

beneficiaries of life insurance proceeds,

scholarships or grants not in excess of college

expenses, municipal bond income, interest for

education savings vehicles used for education, and interest and earnings deferred on qualified

retirement accounts

Definitions (continued)

• Adjustments are deductions from total income

allowed by the IRS to get your Adjusted Gross

Income (AGI) These include: amounts that defer retirement income (IRA, 401k, SEP IRA), and

qualified medical savings contributions (flexible

spending accounts), student loan interest and tuition and fees deduction (IRS 970) (within limits), one-half self employment tax, etc

Definitions (continued)

• Deductions are IRS allowed reduction amounts (standard deduction) or taxpayer determined

amounts (itemized deductions) to get taxable

income from your AGI

• Year Standard Deduction (MFJ)

Definitions (continued)

• Allowable deductions (if you itemize) include

charitable contributions (cash, in kind, and/or

mileage), home mortgage interest, medical

expenses (>7.5% AGI), un-reimbursed qualified job expenses (> 2% AGI), casualty and theft expenses (> 10% AGI), either state and local taxes or state and local general sales taxes, property taxes on

principle residence, etc

Definitions (continued)

• An exemption is an amount of money set by the

government that you can deduct for each qualifying person in your household If you are married with

4 young children still at home, you have 6

Definitions (continued)

• 5 Tax Tables (married filing jointly [Schedule Y-1])

Year If Taxable But not Tax Plus this Of the

income is over over is percentage Excess

Definitions (continued)

• Credits are dollar for dollar reductions in your

taxable liability Credits are worth significantly

more than deductions

• Credits are either refundable (paid to the taxpayer even if the amount of the credits exceeds the tax liability) or non-refundable

• Refundable credits include reductions for earned income, taxes withheld on wages, estimated

income tax payments

• Non-refundable credits include child tax, child and dependent care, elderly and disabled,

adoption, hope learning, and lifetime learning

Understand Tax Planning Strategies to Minimize

Payments for a Given Level of Income

Four key strategies:

1 Maximize Deductions

• Use your home as a tax shelter

• Shift and bunch your deductions to get maximum benefit in a specific year

• Continue to give, with tithes and offerings,

• Keep good records of all other charitable contributions, including mileage and in-kind donations

Tax Planning Strategies (continued)

2 Maximize Long-term Capital Gains Income

• Long-term capital gains rates are taxed less than earned income (in some cases as much as 20% less - 35% versus 15%) Stay in for the long haul

• Manage your portfolio in a tax-efficient basis

Tax Planning Strategies (continued)

3 Receive Tax-Exempt Income

• Key Suggestions

• Look to tax-free investments Municipal bond interest is federal-tax free, and may be state and local tax-free well

• Use Medical Savings Accounts (also called flexible spending accounts) to pay medical bills with before-tax dollars and to reduce income

• Donate to charities with appreciated assets That way you do not pay taxes on the appreciated assets

Tax Planning Strategies (continued)

4 Defer Taxes to the Future or Eliminate Taxes

• Invest as much as your budget will allow in

your 401k/403b/457/Keogh and other deferred retirement plans, especially if they are matched

tax-• IRAs, 401k defer taxes to the future so you

do not have to pay taxes on this money until later

• Invest in education savings vehicles (i.e., 529

Plans and Education IRAs) which eliminate taxes on earnings if the assets are used for qualified educational expenses (exclusions)

Tax Recommendations for Soon to be Graduating Students

• Have a folder that you put all your tax receipts into for tax time—keep it current

• Use an electronic system such as Quicken or Money

to organize your finances These programs make taxes easier if you use them

Tax Recommendations for Students (continued)

• Use prior year’s returns as an example for the

current year

• Make sure you take the same deductions each year

—or at least be aware of them

• Keep prior year’s returns for 7 years

Tax Recommendations for Students (continued)

• Keep good records so you can itemize deductions,

• Get good at showing what non-cash charitable

contributions you make, such as miles you travel for church or scout related activities These can be

deducted at 14 cents per mile in 2006

• Keep records of the non-cash donations you give to Deseret Industries, Salvation Army, etc as these can

be deducted if you itemize

Tax Recommendations for Students (continued)

gains, and offset them if possible with capital losses

• Remember you can offset capital gains with capital losses to manage your investment income

• You can deduct up to $3,000 per year in capital

losses (every little bit helps)

Tax Recommendations for Students (continued)

appreciated long-term capital assets.

• If you donate appreciated assets instead of selling them, you do not have to pay the capital gains on those assets

• Donate the appreciated assets directly to the

charities of your choice

• For an example of paying tithing and other offerings with appreciated assets, see Teaching Tool 8: Tithing Share Transfer Example

your tax bill?

C Understand the Major Tax Features

1 Income Taxes

• Progressive tax meaning that the more you earn the more you pay

• Marginal tax rate

• Percentage of the last dollar that you earned that will go toward federal income taxes

• 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

2 Capital Gains Taxes

• Can be postponed until you sell an asset for a

profit, but rates are dependent on how long the asset is held as well as the marginal tax bracket of the owner

• While you can postpone capital gains taxes, you cannot postpone taxes on distributed earnings and dividends from mutual funds

• Short-term capital gains

• Gains from assets held less than 12 months

• Long-term capital gains – taxed at 15%

• Gains from assets held for 12 months or longer

Capital Gains:

What does Mean For You?

• Avoid frequent trading

• Buy for the long-term—don’t churn your portfolio

• Buy low-turnover, “tax managed” mutual funds

• Index funds are very tax efficient

• New laws make it a requirement to show tax

effects of mutual fund ownership

• Buy individual stocks and make your own mutual fund

• You are not required to make annual distributions

as do mutual funds for individual portfolios

Capital Gains: What Does This Mean

For You (continued)

Home Ownership:

• Gains up to $500,000 for couples and $250,000 for

individuals from home ownership is 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

3 Income-based Key Taxes

• 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

• Capped and adjusted annually for inflation over which income is not taxed

Income-based Key Taxes (continued)

Security + 2.9% Medicare).

• You are only responsible for half of the tax unless you’re self-employed Then you must pay all

15.3%

• Most states impose an income tax; however, some, like Texas and Nevada, do not

• Local income taxes are uncommon; but some larger cities, for example, New York City, impose such a tax

4 Non-Income based Key Taxes

assets owned

one owner to another

of our tax system?

Review of Objectives

said regarding taxes?

planning and how it helps attain your personal goals?

strategies to help lower your taxes?

our tax system?

$1,000 per child under 17.

Tax rates for 2006 for married filing jointly are:

• $15,100 to $61,300 $1,510 plus 15% of the amount over $15,100

• $61,300 to $123,700 $8,440 plus 25% of the amount over $61,300

• Income: Earned Income $80,000

• Un-reimbursed medical bills 7,000

• Un-reimbursed Job-related expenditures 2,000

• Tithes and offerings 9,600

• Calculations: Using the married filling jointly status and the information below,

calculate their taxes first using the standard deduction and then using itemized

deductions Calculate their marginal tax rate and average tax rate on gross income

• Recommendations: Which way should they calculate their taxes? What could they do

to reduce their taxes?

Married with 4 children, 3 under 17; Tax rates: 0 to $15,100, 10%; $15,100 to $61,300, $1,510 plus 15% of the amount over $15,100; $61,300 to $123,700, 8,440 plus 25% of the amount over $61,300 Earned Income

$80,000, Interest Income 10,000, Home mortgage interest $6,800, reimbursed medical bills 7,000, reimbursed job-related expenditures 2,000, Tithing 9,600 Can only deduct medical bills above 7.5% of AGI and job related expenses above 2% of AGI Exemptions $3,300 per person, standard deduction $10,300, and child tax credit $1,000 per child under 17.

Un-Married with 4 children, 3 under 17; Tax rates: 0 to $15,100, 10%; $15,100 to $61,300, $1,510 plus 15% of the amount over $15,100; $61,300 to $123,700, 8,440 plus 25% of the amount over $61,300 Earned Income $80,000, Interest Income 10,000, Home mortgage interest $6,800, Un-reimbursed medical bills 7,000, Job-related expenditures 2,000, Tithing 9,600 Can only deduct medical bills above 7.5% of AGI and job related expenses above 2% of AGI Exemptions $3,300 per person, standard deduction $10,300, and child tax credit $1,000 per child under 17.

Calculations: Standard Deduction Method

• 1 Total Income $90,000

• 2 less $5,000 401k contr (AGI) $85,000

• 3 Minus Standard Deduction -10,300

• 4 Minus Exemption -19,800 $3,300*6

• Equals Taxable income 54,900

• 5 Look up tax in tax table:

• Tax: 1,510 10% on first $15,100

• 5,970 15% on next $39,800

• Calculate tentative tax $7,480

• 6 Child tax credit -3,000 (3 * $1,000)

• 7 Total Tax Due $4,480

Married with 4 children, 3 under 17; Tax rates: 0 to $15,100, 10%; $15,100 to $61,300, $1,510 plus 15% of the amount over $15,100; $61,300 to $123,700, 8,440 plus 25% of the amount over $61,300 Earned Income $80,000, Interest Income 10,000, Home mortgage interest $6,800, Un-reimbursed medical bills 7,000, Job-related expenditures 2,000, Tithing 9,600 Can only deduct medical bills above 7.5% of AGI and job related expenses above 2% of AGI

Exemptions $3,300 per person, standard deduction $10,300, and child tax credit $1,000 per child under 17.

Calculations: Itemized Deduction Method

Married with 4 children, 3 under 17; Tax rates: 0 to $15,100, 10%; $15,100 to $61,300, $1,510 plus 15% of the amount over

$15,100; $61,300 to $123,700, 8,440 plus 25% of the amount over $61,300 Earned Income $75,000, Interest Income 10,000, Home mortgage interest $6,800, Un-reimbursed medical bills 7,000, Job-related expenditures 2,000, Tithing 9,600 Can only

deduct medical bills above 7.5% of AGI and job related expenses above 2% of AGI Exemptions $3,300 per person,

standard deduction $10,300, and child tax credit $1,000 per child under 17.

average tax rate on gross income.

• Their marginal tax rate, the tax rate they would pay

on each new dollar of income is 15% for both the standard and itemized deduction calculation

• Their average tax rate, the rate they actually pay in taxes is their taxes divided by their total income

• Standard deduction = 4,480 / 90,000 = 5.0%

• Itemized deduction = 3,426 / 90,000 = 3.8%

Case Study (continued)

• Method:

• Using the Itemized versus the standard deduction nets a savings of $1,054 over the standard deduction Matt and Janina should use the itemized method as they have more money for their goals

• What could they do to reduce their taxes?

• There are lots of different answers you could give; however, you do not have specific data in the case that leads to any specific

recommendation Following are a few assumptions and ideas:

Case Study (continued)

• If they own a home, they could keep records of their home interest payments and property taxes which are deductible

• If they are involved in charity, they could deduct the miles they drive to and from the charity

• If they have non-cash contributions, such as

donations to Deseret Industries or Goodwill,

they could keep good records of these donations

• If they have appreciated financial assets, they could contribute these to charity instead of cash, reducing AGI and eliminating capital gains

taxes