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Chapter 4
Chapter 4
TAX PLANNING AND STRATEGIES
ACCCKKKKKKKKKKTAXES!

They say you can only


count on death and
taxes (and change..).

Hey..I heard almost 1/2


the people dont have
to pay TAXES!?! Is that
true?
Why are taxes important?

Financial decisions are affected by taxes.

Need to understand how taxes are imposed.

Strategies to reduce taxes so you only pay what you


owe.
What are all of the different taxes 4
that you may pay?

Chapter 4
Income-Based Taxes:
Social Security or FICA
State and local income taxes
Capital gains

Non-income-based taxes
Sales tax
Gas tax
Property taxes
Gift and estate taxes

Excise taxes
Business taxes
Payday
Omnipotent Heroes, Inc
123 Dreary Lane Earning Statement
Sherwood, OR 97140 Period Beginning: 10/1/2016
Period Ending: 10/15/2016
Taxable Marital Status: Single Pay Date: 10/31/2016
Exemptions: Advice number: 123456789
Frieda
Federal: 0 Frankenstein
State: 1
123 Zombie Lane
Sherwood, OR
Earnings 97140Hours
Rate This Year to
Period date
Pillaging $10.00 22.5 $225.00 $5000.00
Village
Gross Pay $225.00

Deductio Statutory
ns
Social Security -13.95 $310.00
Tax
Medicare Tax -3.26 $72.44
FICA - Federal Insurance Contributions Act
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Chapter 4
Social Security Tax and Medicare Tax
a.k.a Payroll tax

Flat percentage rate


SS 6.2%
Employer pays , unless self employed
Withheld up to $118,500 of income

Medicare 2.9%
Employer pays , unless self employed
Additional 0.9% on high income (> $225,000)
State Income Tax Rates
The Federal Income Tax Structure 8

Chapter 4
Progressive or graduate tax- tax rates increase
for higher incomes

Tax brackets or Marginal Tax Rate : The rate at


which you pay taxes on next dollar you earn

Average or Effective Tax Rate: The overall


percentage of tax you pay.
Historical Top Marginal
Income Tax Rate
Eisenhower
91%

Nixon 70%
The New Deal
63%-79%

Regan 50%

Bush 35%
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Marginal Tax Rate Table 0

Chapter 4
2016 Taxable Income Brackets and Rates
Rate Single Filers Married Joint Filers
10% $0 to $9,275 $0 to $18,550
15% $9,276 to $37,650 $18,551 to $75,300
25% $37,651 to $91,150 $75,301 to $151,900
28% $91,151 to $190,150 $151,901 to $231,450
$190,151to
33% $231,451 to $413,350
$413,350
$413,351 to
35% $413,351 to $466,950
$415,050
39.6% >$415,050 >$466,950+

Other schedules for head of household, married filing separately,


and estate and trusts
Source: Internal Revenue Service
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Marginal Tax Rate Table 1

Single filer 2016 rates


If your taxable income is: The tax is:
Over ---- But not over Amount Plus Of the amount
over
$0 $9,275 $0 10% $0
$9,276 37,650 927 15% 9,275
37,651 91,150 5,183 25% 37,650
91,151 190,150 18,588 28% 91,150
190,151 413,350 46,278 33% 190,150
413,351 415,050 119,934 35% 413,350
415,051 -- 120,539 39.6% 415,050

Chapter 4
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Marginal vs Effective rate 2

Chapter 4
Hypothetical example
If your taxable income is: The tax is:
Over ---- But not over Amount Plus Of the amount
over
$0 $50,000 $0 10% $0
50,000 $100,000 $5000 20% $50000
100,000 -- $15,000 30% $100,000

Person 1 Income of $40,000


- Income < $50k
- Tax is 10% of $40k = $4000

- Thus marginal tax rate = effective rate = 10%


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Marginal vs Effective rate 3

Chapter 4
Hypothetical example
If your taxable income is: The tax is:
Over ---- But not over Amount Plus Of the amount
over
$0 $50,000 $0 10% $0
50,000 $100,000 $5000 20% $50000
100,000 -- $10,000 30% $100,000

Person 2 Income of $100,001


- The first $50k is taxed at 10% = $5,000 ($50k * 10%)
- The next $50k is taxed at 20% = $10,000 ($50k * 20%)
- The last $1 is taxed at 30% = $0.3 ($1 * 30%)
----------------------------------------------
Total tax = $15,000.30
Marginal tax bracket = 30%
Effective (or actual) = 15000.30/100,001 = 15.00015%
How to reduce your taxes 1
4

Chapter 4
Reduce your taxable income

Deductions

Credits
Reducing your taxes by 1
reducing your taxable 5

Chapter 4
income
Contributions to retirement programs
401k
Traditional IRAs (income limits apply)

Health Savings Account contributions


Requires an HSA eligible health insurance program

Student loan interest

Qualified education expenses (Tuition and fees)


May not be used if use education credits

Standard exemption - $4050 for each person listed on tax form


Reducing your taxes by 1
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deductions

Chapter 4
Reduces your taxable income by the greater of:

Standard deduction - $6,300 for single, $12,600 for MFJ

Itemized deduction (Schedule A)


State and local taxes
Medical expenses
Property taxes
Interest on mortgage
Charitable gifts
Other stuff
Reducing your taxes by 1
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credits

Chapter 4
Credits are the best because they reduces the tax owed

Education credits
Child tax credits
Child care expenses
Residential energy credits
E.g. solar on the roof
Comparison of Education Credits
Criteria American Opportunity Tax Lifetime Learning Credit Tuition and Fees Deduction
Credit
Maximum credit or Up to $2,500 credit per Up to $2,000 credit per Up to $4,000 taxable income

Chapter 4
benefit eligible student return reduction per return
Refundable or 40% of credit Not refundable Does not apply
nonrefundable
Limit on Modified $90,000 /$180,000 $64,000 / $128,000 $80,000 / $160,000
Adjusted Gross Income -
single / MFJ
Only if student hasn't All years of post secondary All years of post secondary
Number of years of post-
completed 4 years of post education education
secondary education
secondary education before
available
2014
Number of tax years 4 tax years per eligible Unlimited Unlimited
credit available student
Student must be pursuing a Student does not need to be Student must be enrolled at
degree or other recognized pursuing a degree or other eligible educational institution
Type of program required
education credential recognized education for one or more courses
credential
Student must be enrolled at Available for one or more Available for one or more
least half time for at least courses courses at eligible educational
Number of courses
one academic period institution
beginning in 2014
Tuition, required enrollment Tuition and fees required for Tuition and fees required for
Qualified expenses fees and course materials enrollment or attendance enrollment or attendance
needed for course of study
If you are a dependent on someone elses taxes, and they are paying your college expenses
they can apply the credit to their taxes. Credit can only be claimed on one tax return!

For further details, see IRS site


https://www.eitc.irs.gov/Other-Refundable-Credits/educompchart
Other taxable income
Capital Gains and Dividend Income

Capital asset Almost everything you own and use for


personal purposes, pleasure, or investment (IRS publication 544)

Capital gain the amount you make if you sell a capital


asset for more than you bought it

Capital loss the amount you lose when you sell a capital
asset for less than you bought it
Only applies to investment assets, not personal property

Dividend A payment from the company to the


shareholders
Capital Gains taxes

Short-term capital gains tax


For capital gains for assets held less than one year.
Taxed at ordinary income tax rates (marginal rate)

Long-term capital gains tax


For assets held more than one year
0% for taxpayers in the 10% and 15% tax bracket
15% if you are in the 25%, 28%, 33% and 35% bracket
$20% for the 39.6% tax bracket
Long-Term Capital Gains on Homes

Exemption up to $500,000 for couples filing


jointly ($250,000) filing single on sale of
principal residence
Must have been occupied for 2 of the 5 years
prior sale
Property tax
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Chapter 4
Chapter 4
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3
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Help in Preparing Taxes 4

Chapter 4
Handle taxes by yourself.

Tax software TurboTax is most popular, others are


available

Free versions online for simple returns

Worth a few $ to get it right.

Use IRS publications, IRS hotlines, & self-help publications.

Hire a tax specialist CPA or EA (enrolled agent)

Cash Oregon, AARP Tax-Aide Free advice


Example problem
2
5
The Lees, a family of two adults and two dependent children under age

Chapter 4
16, had a gross annual income of $68,000.00 for 2014. Determine their
standard deduction, exemption, and child tax credit amounts, as well as
their marginal and average tax rates assuming their filing status is
married filing jointly.

Step 1 : Std deduction given 2014 table

Step 2: Personal exemption: $3,950 * 4 = $15,800


Example problem
2
The Lees, a family of two adults and two dependent children under age 16, had a gross annual income of
$68,000.00 for 2014. Determine their standard deduction, exemption, and child tax credit amounts, as well
as their marginal and average tax rates assuming their filing status is married filing jointly.6
Step 3 :

Chapter 4
Taxable income = Gross income Adjustments Deductions Exemptions
= $68,000 - $12,400 - $15,800
= $39,800

Step 4: Marginal tax rate (from table) 15%


Step 5: Income tax before credits = $1815 + (0.15 * ($39,800 -
$18,150))
= $5,062.50
Step 6: Credits: 2 children under 16 = $2,000
Example problem
2
The Lees, a family of two adults and two dependent children under age 16, had a gross annual income of
$68,000.00 for 2014. Determine their standard deduction, exemption, and child tax credit amounts, as well
as their marginal and average tax rates assuming their filing status is married filing jointly.7
Step 7: Tax after Credits

Chapter 4

$5063.50 - $2000 = $3063.50

Step 8: Average tax rate = Total tax due / Total income


= $3063.50 / $68,000
= 0.045 = 4.5%
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Things to remember about taxes
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Chapter 4
Determining your marginal tax bracket and
average tax rate.

Terms such as exemptions, AGI, etc.

Type of capital gains (long term and short term)

Types of taxes (Income, payroll, property, )