Basic Federal Income Taxes by ramhood17

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									Basic Federal Income Taxes


Just to gain an understanding, not
to become an expert.
How It All Began
   In 1913, the 16th
    Amendment gave
    Congress the right
    to impose the first
    income tax
   Initial tax rates
    ranged from 1 to 8%
Importance of Tax Planning
                   Taxes are your
                    largest annual
                    expense
                   The average
                    American works
                    more than 4 months
                    just to pay his/hers
                    taxes
Income Tax Structure
   Income tax -- progressive tax meaning that
    the more you earn the more you pay
   Tax brackets -- income ranges for which the
    same marginal tax rate applies
   Marginal tax rate -- percentage of the last
    dollar that you earned that will go toward
    federal income taxes
Income Tax Structure (cont’d)
   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
Capital Gains Taxes and the
Taxpayer Relief Act of 1997
   Capital gains tax -- can be postponed
    until you sell an asset for a profit
   Short-term capital gains -- gains made
    from assets held less than 12 months
    Long-term capital gains -- gains made
    from assets held for 12 months or
    longer
Tax Rates Associated With
Capital Gains
   These rates are dependent on how long
    the asset is held as well as the marginal
    tax bracket of the owner.
   Short-term rate – 28%
   Long-term rate – 20%, unless you’re in
    the 15% tax bracket and then it is 10%
Tax Rates Associated With
Capital Gains After 2000
   Applies to assets
    purchased in or after
    2001and held for 5
    years
   Long-term rate of
    18%, unless you’re
    in the 15% tax
    bracket and then it
    is 8%
What Does This Mean For You?

   Avoid frequent
    trading
   Buy low-turnover,
    “tax managed”
    mutual funds
   Buy individual
    stocks and make
    your own mutual
    fund
Capital Gains Taxes On Homes
                  Gains up to $500,000
                   for couples and
                   $250,000 for individuals
                   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
Filing Status Classifications
   Single
   Married filing jointly
   Married filing separately
   Head of household
Cost of Living Increases in the
Tax Brackets
   The tax brackets change annually to insure
    that no one pays more income tax just
    because earnings increased with inflation.
   Bracket creep -- a tax liability increase
    caused by inflation.
   Example -- the income minimum for the 28%
    tax bracket for joint filers increased from
    $42,350 to $43,050 in 1999.
Paying Your Income Taxes
   Withholdings -- tax payment from each
    paycheck, determined on the basis if
    income and W-4 form
   Quarterly estimated payments
   Payments with the tax return (the
    dreaded April 15th)
   Withholdings from stock, retirement
    funds, and prize or gambling winnings
Social Security or FICA
   Social Security -- 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
   Social Security cap, adjusted annually for
    inflation, was $72,600 in 1999. Income over
    this amount is not taxed.
Social Security or FICA (cont’d)
   Medicare -- a health care insurance
    program for elderly and disabled.
   Tax rate of 1.45% of gross salary, with
    no annual cap.
   Total FICA tax rate -- 15.3% (12.4%
    Social Security + 2.9% Medicare).
   You are only responsible for half of the
    tax unless you’re self-employed.
State and Local Income Taxes
   Most states impose
    an income tax;
    however, some, like
    Texas, do not.
   Local income taxes
    are uncommon; but
    some larger cities,
    for example, New
    York City, impose
    such a tax.
Other Non-Income-Based Taxes
That You Face
   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
Calculating Your Taxes
   Who has to file an income tax return?
   Determining gross or total income
   Calculating adjusted gross income (AGI)
   Subtracting deductions
   Claiming your exemptions
   Calculating your base income tax
   Determining your credits
   Determining your final tax liability
Who Has to File an Income Tax
Return?
   Everyone who earns more than $14,400 must
    file an income tax return.
   Some people who earn less, depending on
    age, filing status, and dependency status
    must file a return.
   People who have more than $700 of
    unearned income must file.
   Note: All thresholds are for 1999 and are
    adjusted annually for inflation.
Sources of Taxable Income
                   Wages, salaries, and
                    tips
                   Capital gains,
                    dividends, and interest
                   Alimony
                   Pension funds and IRA
                    distributions
                   Business and farm
                    income
                   Rental and royalty
                    income
                   Social Security and
                    unemployment benefits
Sources of Tax-Exempt Income
   Roth IRA earnings
   State and local municipal bond interest
   Gifts and inheritances
   Child support payments
   Federal income tax refunds
   Veterans’ and welfare benefits
Look at Juanita Linzey
     Salary--$29,000      $90 from friend who rides to
     $10,000 in life       work in Juanita’s vehicle
      insurance proceeds  $60 in lottery winning
      from deceased aunt  $420 state income tax refund-
     $240 in interest on   -she itemized
      savings              $570 federal income tax
     $5,000 in alimony     refund
      from ex-husband      $170 worth of dental services
     $1,200 in child       traded for a quilt she gave the
      support               dentist
     $500 cash            $1,600 tuition scholarship she
      Christmas gift from   received to go to college part
      parents               time last year
Subtracting Adjustments to
Calculate AGI
 –   Alimony payments
 –   Selected moving expenses
 –   Selected IRA and other retirement
     contributions
 –   50% for Social Security and Medicare (self-
     employed only)
 –   Penalties for early withdrawal
 –   Student loan interest, with limitations
Subtracting Deductions from
AGI
   Itemized deductions (Normally, you
    must first own a home.)
   Standard deductions
Itemized vs. Standard
                          Take itemized if sum of
                           following is greater
   Standard is
                           – Medical over 7.5%
    – Single--4,250
                           – State income and real
    – Married--7,100         estate taxes
                           – Home mortgage interest
    – Head of                and Home equity loan
      Household-             interest
      $6,250
                           – Gifts to charity
                           – Job Expenses-over 2%
    – In 2001
                           – Casulty losses
Using Standard or Itemized??

   Take the larger of
    the two amounts
   If close, consider
    bunching deductions
   Don’t let laziness or
    poor recordkeeping
    cost you money!
Additional Deductions for
Elderly or Blind Taxpayers
   Unmarried taxpayer -- $1,050 ($2,100 if
    both elderly and blind).
   Married taxpayer -- $850 ($1,700 if both
    elderly and blind).
   Amounts shown are for 1999 and are
    adjusted annually for inflation.
Claiming Your Exemptions
   Exemptions are meant to provide
    everyone with some untaxed income,
    provided you don’t earn too much.
   Personal exemptions -- $2,750 (1999).
   Dependency exemptions
    –   Three-step dependency test
   Exemption phaseout.
Calculating Your Base Income
Tax on Taxable Income
   Tax tables in the booklet.
   Tax rate schedules -- must be used if
    income exceeds $100,000.
   Alternative minimum tax -- to prevent
    the very wealthy from using the tax
    breaks to pay little or no tax.
Determining Your Credits
   Child credit
   Hope Scholarship credit
   Lifetime Learning credit
   Child and dependent care credit
   Earned income credit (EIC)
   Adoption credit
   Other credits, such as elderly and disabled
    taxpayer credits
Other Filing Considerations

   Picking the right form
   Determining how to file
   Filing late or amended returns
   Where to get help
Choosing a Tax Form
   1040EZ
    –   taxable income less than $50,000
    –   can’t itemize or claim dependents
   1040A
    –   taxable income less than $50,000
    –   allows for more sources of income
Choosing a Tax Form (cont’d)
   1040 “long form”
    –   allows the use of schedules
    –   only form that allows you to itemize
        deductions
   Know the schedules
How To File?

   Electronic Filing
    – Refund within 3
      weeks
    – Less chance of
      processing error
    – Cost?
   Filing by mail
Filing Late and Amended
Returns
   Filing late
    –   Form 4868
    –   Penalties -- 10% of tax bill
   Amended returns
    –   Form 1040X
    –   Limitations -- 3 years after the original tax
        due date
Reasons for Being Audited
   Random
   Previous errors
   High income level
   Filing a Schedule C
   Audits allow the IRS to
    conduct spot checks of
    returns to ensure
    compliance to the tax
    laws and regulations
Preparing for an Audit
   Reexamine the areas in question
   Gather all supporting data
   Anticipate any probable questions
   Hire a tax accountant or attorney (if
    necessary)
   Note: the best way to win an audit is to
    keep excellent records
Appealing an Audit Outcome
                  Appeal with the
                   auditor
                  Appeal with the
                   auditor’s manager
                  File a formal appeal
                  Go to tax court
Help in Preparing Your Taxes
   IRS Publication 17
   IRS hotline
   Self-help tax publications
   Computer programs
   Videos
   Tax specialists--be sure to start early
Tax Planning to Minimize
Payments
   Maximize your deductions.
   Look to capital gains income in
    particular if you are in the top tax
    brackets.
   Receive tax-exempt income such as
    income for municipal bonds.
   Defer taxes to the future.
Maximizing Your Deductions
   Using tax-deferred retirement programs
    to reduce taxes.
   Using your home as a tax shelter.
   Shifting and bunching your deductions.
Look to Capital Gains Income
   Long-term capital
    gains rates are
    taxed less than your
    earned income. In
    some cases as
    much as 19.6% less.
   Taxes are
    postponed until the
    assets are sold.
Shift Income to Family in Lower
Tax Brackets
   Gifts -- $10,000 per person ($20,000
    per couple) per year tax-free.
   Trusts -- hold property for another.
Receive Tax-Exempt Income
   Municipal bond interest from state and
    local government debt.
   The higher your marginal tax bracket,
    the more beneficial tax-free income is.
Defer Taxes to the Future
   Traditional IRAs,401(k) plans, and
    Keogh plans defer taxes to the future.
   Roth IRA earnings are never taxed.
   Long-term capital gains taxes are not
    paid until the asset is sold.
Try helping out Ted and Alice

                   The facts are given
                    to you, see how you
                    fare.
Ted and Alice

   Gross Income
    – Ted’s Salary      $55,000
    – Alice’s Salary    31,500
    – Non-municipal Int    500
    – Dividends          1,000
    – Capital Gain        2,000
   Total Gross Income $90,000
    Ted and Alice
   Itemized Deductions--with mortgage
    interest of $12,500 they would be better
    off itemizing
   Medical       0
   Real estate taxes 2,200
   Mortgage Interest 12,500
   Charitable Contributions--1,200
   Business Expenses---880
   Total 16,780
Ted and Alice

   Personal Exemptions
   5 times 2,700 equals 13,500
   Taxable Income
   90,000 less 16,780 less 13,500 equals
    59,720
   Tax = 11,216.10

								
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