MBA620 05 tax planning 19sep07

Personal Finance Another Perspective Tax Planning Objectives • • • • A Understand what our leaders have said regarding taxes B Understand the importance of tax planning and how it helps attain your personal goals C Understand the tax process and strategies to help lower your taxes (legally and honestly) D Understand the major tax features of our tax system Your Personal Financial Plan • Section V.: Taxes • • What Tax Form and Tax Strategies did you use last year? • What was your marginal and average tax rates? Action Plan: • What Tax Form and Tax Strategies should you use this year? • What else can and should you to reduce your tax bill to Uncle Sam? A Understand our Leaders Counsel on Taxes • • The Lord has said: • Let no man break the laws of the land, for he 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) The 12th Article of Faith states: • We believe in being subject to kings, presidents, rulers, and magistrates, in obeying, honoring, and sustaining the law Our Leaders Counsel (continued) • Some have tried to minimize this obligation 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) • • Questions • Any questions about what our leaders have said about paying taxes? B Understand How Tax Planning can help attain your Personal Goals • Why tax planning? • • • Taxes are your largest single annual expense The average American works more than months just to pay his or her taxes In sum: the less you pay Uncle Sam, the more 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 Goals Budget Cash Management Estate Planning Taxes Savings and Debt Retirement Planning Investing Insurance Questions • Any questions on the impact of taxes and your personal goals? Non-Income based Key Taxes • Excise “sin taxes” and state sales taxes • • Real estate and property taxes • • Imposed when goods are purchased 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 children, 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: • 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 Married with children, under 17; Tax rates: 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, Unreimbursed 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 children, under 17; Tax rates: 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 • • • • • • • • • • • Total Income $90,000 less $5,000 401k contr (AGI) $85,000 Minus Standard Deduction -10,300 Minus Exemption -19,800 $3,300*6 Equals Taxable income 54,900 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 Child tax credit -3,000 (3 * $1,000) Total Tax Due $4,480 Married with children, under 17; Tax rates: 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 • Total Income (earned +interest) $90,000 • less $5,000 401k contribution (AGI) $85,000 • 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 • Minus Income Exemptions 19,800 (3,300*6) • Equals Taxable income 47,875 • 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 • Child tax credit -3,000.00 (1,000 * kids under 18) • Total Taxes Due $3,426.25 Married with children, under 17; Tax rates: 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 to reduce their taxes? • There are lots of different answers you could give; however, you not have specific data in the case that leads to any specific recommendation Following are a few assumptions and ideas: Case Study (continued) • 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) • 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) • 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) • 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? Case Study #2 Answer • • Any legal method However, if it seems to good to be true, it probably is, so get another opinion Its not worth losing your integrity or going to prison over bad tax advice • You are ultimately responsible for your choices and for paying taxes Where you get your tax advice, and how and what you pay for your taxes and other obligations is your choice Your best tax advice should come from those who make it a business of giving tax advice In addition, the IRS has many publications which can help you as you determine the taxes you should pay [...]... ways to reduce your tax bill? C Understand the Major Tax Features • Four types of taxes: • • • • 1 Income taxes 2 Capital Gains taxes 3 Income based taxes 4 Non-income based taxes 1 Income Taxes • 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... 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 beforetax 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...C Understand the Tax Process and Strategies to Reduce Taxes 1 Start with income from all sources less exclusions = Gross Income 2 Subtract adjustments to Gross Income = Adjusted Gross Income (AGI) 3 Subtract the greater of Standard or Itemized Deductions 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... 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 • Excise “sin taxes” and state sales taxes • • Real estate and property taxes • • Imposed when goods are purchased Imposed annually or semi-annually on assets owned Gift and estate taxes • Imposed when... 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 • 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... capital gains taxes are not paid until the asset is sold • Maintain a long-term buy and hold strategy on mutual funds and stocks and you pay no taxes until you sell 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... which income is not taxed Medicare • A health care insurance program for elderly and disabled • Tax rate of 1.45% of gross salary, with no annual cap • • Income-based Key Taxes (continued) • Total FICA tax rate is 15.3% (12.4% Social 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% State and Local Income Taxes • • Most states... 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... and local taxes or state and local general sales taxes, property taxes on principle residence, etc Definitions (continued) • 4 Exemptions • 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 exemptions • Year Exemption Amount • 2003 $3 ,050 • 2004 3,100 • 2 005 3,200... Understand Tax Planning Strategies to Minimize Payments for a Given Level of Income Four key strategies: 1 Maximize Deductions • Key Suggestions • • • • 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 ... reduce your tax bill? C Understand the Major Tax Features • Four types of taxes: • • • • Income taxes Capital Gains taxes Income based taxes Non-income based taxes Income Taxes • Income taxes Progressive... about what our leaders have said about paying taxes? B Understand How Tax Planning can help attain your Personal Goals • Why tax planning? • • • Taxes are your largest single annual expense The... Washington, D.C., http://taxfoundation.org/UserFiles/Image /Tax- Freedom-Day/2006 The Impact of Taxes Goals Budget Cash Management Estate Planning Taxes Savings and Debt Retirement Planning Investing