C. Understand the Major Tax Features
4. Non-Income based Key Taxes
• 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
Questions
• Any questions on the major tax features of our tax system?
Review of Objectives
• A. Do you understand what our leaders have said regarding taxes?
• B. Do you understand the importance of tax planning and how it helps attain your personal goals?
• C. Do you understand the tax process and strategies to help lower your taxes?
• D. Do you understand the major tax features of our tax system?
Case Study #1
Data: Matt and Janina, ages 42 and 40, are married and filling out their 2006 taxes. They have 4 children, 3 under 17 and one a dependent in college. They contributed $5,000 to a traditional IRA in 2006. They can only deduct medical bills above 7.5% of AGI, and job related expenses above 2% of your AGI. Exemptions are $3,300 per person, the standard deduction for married filing jointly is $10,300, and the child tax credit is
$1,000 per child under 17.
Tax rates for 2006 for married filing jointly are:
• 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
• Income: Earned Income $80,000
• Interest Income 10,000
• Expenses: Home mortgage interest 6,800
• 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, Un-reimbursed medical bills 7,000, Un- 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.
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
• 1. Total Income (earned +interest) $90,000
• 2. less $5,000 401k contribution (AGI) $85,000
• 3. Deductions
• Home Mortgage Interest 6,800
• Medical Expenses 625 (7,000-(85,000*.075)
• Job-related Expenditures 300 (2,000-(85,000*.02)
• Tithing 9,600
• Total Deductions 17,325
• 4. Minus Income Exemptions 19,800 (3,300*6)
• Equals Taxable income 47,875
• 5. Look up Tax in Table 1,510.00 10% on first 15,100
• 4,916.25 15% on next 32,775
• Calculated tentative tax $6,426.25
• 6. Child tax credit -3,000.00 (1,000 * 3 kids under 18)
• 7. Total Taxes Due $3,426.25
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.
• Calculations: Calculate their marginal and 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)
• Recommendations
• 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)
• 1. Maximize Deductions
• 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
Case Study (continued)
• 2. Emphasize Capital Gains and Stock Dividends
• If they have investments, they could use a passive strategy and purchase low-turnover mutual funds to minimize their mutual fund distributions (and taxes), increase long-term
capital gains (which are taxed at a lower 15% or 5%, depending on your marginal tax rate, rather than your marginal tax rate)
• If they invest in stocks, stock dividends are taxed at a preferential rate of 15% versus bond interest at their marginal tax rate.
Case Study (continued)
• 3. Receive tax-exempt income
• It their work has a flexible spending plan (FSP), they could contribute to their FSP to pay medical bills with pre-tax dollars and reduce their AGI
• If they have investments, they could invest in municipal bonds which are federal tax-free
Case Study (continued)
• 4. Defer taxes to the future or eliminate future taxes
• If they have qualified plans at work, they could contribute a 401k, 403b or 457 plan. This might also have a match and it would reduce their AGI
• They both could contribute to a traditional or Roth IRA which would also reduce their AGI
• They have kids, they could contribute to 529 and Education IRA plans for their kids, which would reduce their investment income in the future
• If they wanted to save for retirement, they could use a a Roth IRA/401k/403b and never pay
taxes on these earnings again
Case Study #2
Data
• Your friend Brian, a financial analyst, comes to you with this sure-fire method of reducing taxes. He says that if you buy into this product (this product can be many different types of tax-schemes), you will not have to pay taxes on the earnings and it will save you taxes as well. It doesn’t sound right, so Brian comes and asks:
Application
• To what lengths should you go to avoid taxes?
• Where should your best tax advice come from?