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 do 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 4
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?
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 Due or
Amount of
Refund
Definitions
• 1. Total Income
• 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)
• 2. Adjustments
• 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), onehalf self employment tax, etc.
Definitions (continued)
• 3. Standard Deductions
• 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)
• 2003
$9,500
• 2004
9,700
• 2005
10,000
• 2006
10,300
• 2007
10,700
Definitions (continued)
• 3. Itemized Deductions
• 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)
• 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
• 2005
3,200
• 2006
3,300
• 2007
3,400
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
2005
0 14,600
0 10%
0
14,600 59,400 1,460 15%
14,600
59,400 119,950 8,180 25%
59,400
119,950 182,800 23,318 28%
119,950
2006
0 15,100
0 10%
0
15,100 61,300
1,510 15%
15,100
61,300 123,700 8,440 25%
61,300
123,700
188,450 24,040 28%
123,700
2007
0 $15,650
0 10%
0
$15,650 $63,700 $1,565 15%
$15,650
$63,700 $128,500 $8,772 25%
$67,300
$128,500 $195,850 $24,972 28%
$128,500
Definitions (continued)
• 6. Credits
• 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
• 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 Strategies (continued)
2. Maximize Long-term Capital Gains Income
• Key Suggestions
• Long-term 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 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 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 to the Future or Eliminate Taxes
• Key Suggestions
•
•
Invest as much as your budget will allow in
your 401k/403b/457/Keogh and other taxdeferred retirement plans, especially if they are
matched.
• 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
•
1. Be organized with your record keeping
•
•
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)
•
2. Keep prior year’s return
•
•
•
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)
•
3. Go through checkbook and remember:
•
•
•
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)
•
4. Spend time in December estimating capital
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)
•
5. Pay your tithes and offerings with
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.
Questions
• Any questions on legal 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 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
• 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
Capital Gains:
What does Mean For You?
Investing:
• 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
• Social Security or FICA
• 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.
• 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 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
• 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
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, 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 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?
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.