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©2013, College for Financial Planning, all rights reserved.

Expectations of Students

• • • Commitment of time and energy Read the assignments

prior

to class This course will help you: o o o pass the CFP ® Certification Examination better serve your clients/ grow your business be successful on the College’s end-of course examination 1-2

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 Professor contact information Lobby & Welcome e-mail Tutorial in Lobby Status changes Text chat Files for students Recordings Access Poll Layout   1-3

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Income Tax Planning Module 1 Income Tax Concepts, Basic Terminology & Tax Calculations

©2013, College for Financial Planning, all rights reserved.

Learning Objectives

1–1: Describe terms related to income taxation.

1–2: Identify the steps in the tax calculation process.

1–3: Identify items of inclusion, exclusions, deductions, or tax credits.

1–4: Analyze a situation to calculate total income for tax purposes.

1–5: Analyze a situation to calculate adjusted gross income.

1–6: Analyze a situation to calculate taxable income.

1–7: Analyze a situation to calculate available tax credits or total tax due.

1–8: Analyze a situation to calculate the equivalent tax benefit of exclusions or deductions to tax credits.

1–9: Evaluate a situation to select fundamental methods of managing the client’s tax liability.

1-5

Video

• • •

Play Video

LOs as Your GPS 5:00 minutes Play video from Video Layout

Text chat or other questions

1-6

Questions to Get Us Warmed Up

1-7

Learning Objectives

1–1: Describe terms related to income taxation.

1–2: Identify the steps in the tax calculation process.

1–3: Identify items of inclusion, exclusions, deductions, or tax credits.

1–4: Analyze a situation to calculate total income for tax purposes.

1–5: Analyze a situation to calculate adjusted gross income.

1–6: Analyze a situation to calculate taxable income.

1–7: Analyze a situation to calculate available tax credits or total tax due.

1–8: Analyze a situation to calculate the equivalent tax benefit of exclusions or deductions to tax credits.

1–9: Evaluate a situation to select fundamental methods of managing the client’s tax liability.

1-8

Income Tax Terms

Gross (total) income

• Income from all sources, unless specially excluded by tax law; total income for tax purposes

Adjustments to income

• Deductions that reduce total (gross) income to arrive at adjusted gross income (AGI)

Adjusted gross income (AGI)

• Amount remaining after making allowable adjustments to income 1-9

Income Tax Terms

Standard deduction

• Amount by which nonitemizers reduce AGI before subtracting personal exemptions to arrive at taxable income

Itemized deductions

• Typically personal expenses allowed as a deduction from AGI; amount by which itemizers reduce AGI before subtracting personal exemptions to arrive at taxable income 1-10

Income Tax Terms

Personal and dependency exemptions

• A deduction amount for the taxpayer, spouse and dependents. Deducted from AGI, in arriving at taxable income.

Taxable income

• Amount on which tax the income tax is computed 1-11

Income Tax Terms

Filing status

• One of four categories; determines standard deduction amount allowed: (1) married filing jointly, (2) married filing separately, (3) single, or (4) head of household

Marginal income tax bracket

• Percentage of tax payable on last dollar of taxable income 1-12

Income Tax Term

Tax credit

• A dollar-for-dollar offset against tax liability

Exclusions

• Items received by a taxpayer that represent an economic benefit that are not taxed  muni bond interest, gifts received, fringe benefits, etc.

Miscellaneous deductions

• Miscellaneous itemized deductions not subject to the 2% AGI floor 1-13

Income Tax Term

Tier II miscellaneous deductions

• Miscellaneous itemized deductions that are deductible to the extent that the total exceeds 2% of AGI

Tax liability

• The amount of taxes owed after subtracting all allowable credits 1-14

Steps in the Calculation Process

Determine total (gross) income for tax purposes.

Subtract Adjustments to Income.

Determine allowable itemized deductions.

Subtract allowable itemized deductions, or standard deduction, from adjusted gross income.

1-15

Steps in the Calculation Process

Determine personal exemption amount that can be claimed.

Calculate taxable income.

Calculate tax using appropriate tax rate schedule or tax table.

Subtract tax credits and add additional taxes to determine tax liability.

1-16

Form 1040

1-17

Gross Income

1-18

Adjusted Gross Income

1-19

Tax Computation

1-20

Learning Objectives

1–1: Describe terms related to income taxation.

1–2: Identify the steps in the tax calculation process.

1–3: Identify items of inclusion, exclusions, deductions, or tax credits.

1–4: Analyze a situation to calculate total income for tax purposes.

1–5: Analyze a situation to calculate adjusted gross income.

1–6: Analyze a situation to calculate taxable income.

1–7: Analyze a situation to calculate available tax credits or total tax due.

1–8: Analyze a situation to calculate the equivalent tax benefit of exclusions or deductions to tax credits.

1–9: Evaluate a situation to select fundamental methods of managing the client’s tax liability.

1-21

Adjustments to Income

• • • • • • • • • Qualified education interest Educator expense deduction Tuition and fees (higher education) deduction IRA deduction Keogh contributions (for business owner) Discrimination lawsuit expenses Penalty on early withdrawal of savings Alimony deduction One-half of the self-employment tax

Equals AGI: THE LINE

1-22

Video

• • •

Play Video at break

The Gross Income Song 2 ½ minutes Play video from Video Layout

Text chat or other questions

1-23

Higher Education Expense Deduction

• • • Qualified Higher Education Expenses (QHEE) o o o Tuition and fees required for enrollment Books, supplies, and equipment generally not QHEE (only if paid to school as a condition of enrollment) Room, board, insurance, and other living expenses not QHEE Taxpayer, spouse, or dependent Does NOT apply if: o o o Taxpayer can be claimed as dependent by another Married taxpayers file separately AGI limits exceeded 1-24

Higher Education Expense Deduction

Single $4,000 $65,000 AGI $2,000 $80,000 AGI None MFJ $4,000 $130,000 AGI $2,000 $160,000 AGI None 1-25

Individual Retirement Accounts

• • • Contribution limit: 100% of earned income up $5,500 (spousal IRAs allowed), $1,000 age 50 catch-up No income limits if taxpayer is not active participant Deductibility may be limited if taxpayer is treated as active participant o o o DC plan—any annual additions (employee or employer contributions, or forfeitures) DB plan—eligible to participate More details in Retirement Planning course 1-26

IRA Deductibility Active Participants (2013)

$59,000 AGI $69,000 AGI

Single

Full Partial

MFJ both active

Full $95,000 AGI Partial $115,000 AGI None None

1-27

IRA Deductibility Active Participants (2013) Married Filing Jointly, One Spouse Active Active Spouse

Full $95,000 AGI $115,000 AGI Partial None

Non Active Spouse

Full $178,000 AGI $188,000 AGI None Partial

1-28

Itemized Deductions

• • • • • • • • • Medical expenses (after 7.5% or 10% floor) State & local income taxes or sales tax Home mortgage interest including MIP Property taxes Investment interest expense: Module 6 Charitable contributions: Module 7 Casualty & theft losses: Module 4 Miscellaneous deductions Tier II miscellaneous itemized deductions 1-29

Qualified Mortgage Interest

• • • • Acquisition indebtedness Home equity indebtedness Treatment of points o o MIP On acquisition On refinance 1-30

Mortgage Insurance Premiums

• • • Qualified mortgage insurance premiums paid or accrued during 2007-2011 in connection with acquisition indebtedness in 2007 to 2013 are treated as qualified home mortgage interest. Phaseout of 10% for each $1,000 (or fraction thereof) that the taxpayers’ adjusted gross income (AGI) exceeds $100,000 Purchase of residence from 2007 through 2013 only 1-31

Itemized Deductions

• • • •

Tier II Miscellaneous Itemized Deductions

Collection/determination of a tax liability Unreimbursed employee business expenses Production of income Deducted only to the extent that the total exceeds 2% of AGI 1-32

Deductions & Exemptions

Standard deduction

Single Joint filers Head of Household Married separate $6,100 $12,200 $8,950 $6,100 Additional for elderly or blind Single Married

Exemptions

$1,500 $1,200 $3,900 1-33

Adoption Credit

• • • • • • • Nonrefundable credit up to $12,970 (for 2013) Reasonable expenses—travel, court costs attorney fees, etc.

Under age 18 or unable to care for self Not available for adopting stepchildren Phaseout between approximately $195,000 and $235,000 If special needs adoption; no out of pocket necessary Just know concept, don’t need to memorize numbers 1-34

Child Tax Credit

• • • • $1,000 credit per dependent child Just for having a dependent under age 17 Sometimes refundable based on complex formula taking into account the earned income credit (which is a refundable tax credit) Phased out $50 for every $1,000 above $110,000 for joint filers, $75,000 for single filers 1-35

Child & Dependent Care Credit

• • • • No phaseouts!

Qualifying expenses to allow parent(s) to be employed Qualifying individuals include o o care for dependent under age 13 taxpayer has a dependent (such as a parent) or spouse unable to care for themselves 20% of qualified expenses, up to o o $3,000 for one child $6,000 for 2 or more children 1-36

Calculating Federal Income Tax

Total (gross) income — Adjustment to income* = Adjusted gross income — Standard deduction or — Itemized deductions** — Personal exemption amount = Taxable income IRA/Keogh Alimony paid Interest forfeitures One-half of self-employment tax $2,500 student loan interest Self-employed health insurance deduct.

Educator expenses/tuition & fees deduct.

Medical expenses > 10% (7.5%) of AGI State & local income (or sales) taxes Real & personal property taxes paid Mortgage and investment interest Charitable contributions Casualty loss > 10% of AGI Miscellaneous expenses > 2% of AGI, with certain exceptions * deductions for AGI **deductions from AGI 1-37

Calculating Federal Income Tax

Tax from table or schedule — Credits + Other taxes payable = Net tax liability Child/dependent care Child tax credit Elderly/disabled Foreign tax General business Education Self-employment tax Alternative minimum tax (AMT) Tax on premature distributions 1-38

Tax Rate Schedule

Assume a married couple filing jointly with $250,000 taxable income.

Married Individuals (and surviving spouses) Filing Joint Returns

$0  $17,850 10% of taxable income 17,850  72,500 1,785.00

15% 17,850 72,500  146,400 9,982.50

25% 72,500 146,400  223,050  398,350  223,050 398,350 450,000 28,457.50

49,919.50

107,768.00

28% 33% 35% 146,400 223,050 398,350 450,000  125,846.00

39.6% 450,000 The tax is $49,919.50 + 33%(250,000 – 223,050). $49,919.50 + $8,893.50 = $58,813.00.

1-39

Major Forms & Schedules

• Itemized Deductions • Interest and Ordinary Dividends • Sole Proprietorship – profit or loss from business • Capital Gains and Losses • S Corporations, Partnerships, Rental Real Estate • Self-employment Tax 1-40

Learning Objectives

1–1: Describe terms related to income taxation.

1–2: Identify the steps in the tax calculation process.

1–3: Identify items of inclusion, exclusions, deductions, or tax credits.

1–4: Analyze a situation to calculate total income for tax purposes.

1–5: Analyze a situation to calculate adjusted gross income.

1–6: Analyze a situation to calculate taxable income.

1–7: Analyze a situation to calculate available tax credits or total tax due.

1–8: Analyze a situation to calculate the equivalent tax benefit of exclusions or deductions to tax credits.

1–9: Evaluate a situation to select fundamental methods of managing the client’s tax liability.

1-41

Tax Benefit

Equivalent Tax Benefit of Exclusions or Deductions to Tax Credits

The equivalent tax benefit of exclusions or deductions to tax credits (or tax savings) can be determined by applying the following formula: TC  d  m The equivalent tax benefit of a tax credit to an exclusion or deduction can be determined by applying the following formula: d  TC m Where: TC = amount of tax credit (tax savings) d m = before-tax benefit (amount of exclusion or deduction) = marginal income tax bracket 1-42

Basic Tax Planning Techniques

• Tax Avoidance o Use of exclusions, deductions, and credits • Tax Deferral o IRAs, pension plans, etc.

• Conversion o Lower rates apply to LTCGs • Income Shifting (discussed in Module 7) o Allows income to be taxed at potentially lower rates 1-43

Review Question 1

All of the following are itemized deductions except a.

b.

c.

d.

local income taxes.

investment interest expense.

casualty and theft losses.

qualified student loan interest. 1-44

Review Question 2

Taxable income is the amount a.

b.

c.

d.

remaining after adjustments to income are subtracted.

from which allowable itemized deductions are subtracted.

used to determine the tax liability.

to which tax credits are applied.

1-45

Review Question 3

The following summarizes several financial events in the life of James Grant during the current tax year: a.

b.

c.

d.

e.

o o He received a $100,000 inheritance.

He had gambling winnings of $50,000.

o o He had itemized deductions of $10,000.

He paid student loan interest of $4,200.

What is James’ total (gross) income for the current tax year?

$35,800 $40,000 $50,000 $140,000 $150,000 1-46

Review Question 4

Lowell and Thelma Jordan are married and will file a joint return for the current tax year. They have provided you with the following information: Lowell’s salary Thelma’s salary Unemployment compensation Net capital loss Private-activity municipal bond interest $60,000 $25,000 $10,000 $ 8,000 $ 4,200 Based on the information given, what is Lowell and Thelma’s adjusted gross income for the current tax year?

a.

b.

c.

d.

$77,000 $91,200 $92,000 $99,200 1-47

Review Question 5

Which one of the following items is not included in the computation of total (gross) income?

a.

b.

c.

d.

tips received partnership income sole proprietorship loss penalty on early withdrawal of savings 1-48

Review Question 6

Which one of the following is not an adjustment to income?

a.

b.

c.

d.

qualified education interest alimony payments qualified adoption expenses self-employed health insurance deductions 1-49

Review Question 7

Which of the following is not a step in the tax calculation process?

a.

b.

c.

d.

e.

Determine gross income.

Subtract adjustments to income from gross income to get adjusted gross income.

Deduct the greater of itemized deductions or the standard deduction.

Determine the personal exemption amount that can be deducted.

Subtract credits from taxable income to compute net tax due.

1-50

Review Question 8

George Wells made a $3,000 deductible contribution to his IRA in the current tax year. What amount of tax credit would be necessary to provide a tax benefit that is equal to that provided by the IRA contribution if George is in the 33% marginal income tax bracket?

a.

b.

c.

$ 990 $3,000 $9,091 1-51

Review Question 9

a.

b.

c.

Sarah Mills has two dependent children who attend Sun Valley Day Care while she is at work. She will claim a $1,200 credit for child and dependent care expenses in the current tax year. What amount of deduction would be necessary to provide a tax benefit that is equal to that provided by the child care credit if Sarah is in the 15% marginal income tax bracket?

$ 180 $1,411 $8,000 1-52

Review Question 10

Janet and Bruce Robinson, both age 68, are married taxpayers filing jointly with itemized deductions consisting of the following: Home mortgage interest State income taxes Property taxes $19,500 $8,700 $5,200 Charitable contributions Tax return preparation fee $6,200 $895 Unreimbursed medical expenses $18,460 Their AGI for 2013 is $452,200. What is the amount of their allowable itemized deductions? a.

b.

c.

d.

$34,400 $35,034 $40,495 $58,955 1-53

Review Question 11

Mary is an active participant in an employer-sponsored retirement plan, but her husband, Frank, is not. Their combined AGI for 2013 is $195,000. They each contributed $5,500 to an IRA this year. Which one of the following statements is correct regarding the deductibility of the IRA contributions?

a.

b.

c.

Neither Mary nor Frank may deduct an IRA contribution.

Both Frank and Mary may deduct their IRA contributions.

Frank may deduct his IRA contribution, but Mary may not deduct hers. 1-54

Review Question 12

Mildred is an active participant in an employer sponsored retirement plan, but her husband, Franklin, is not. Their combined AGI for 2013 is $125,000. They each contributed $5,000 to an IRA this year. Which one of the following statements is correct regarding the deductibility of the IRA contributions?

a.

b.

c.

Neither Mildred nor Franklin may deduct an IRA contribution.

Both Franklin and Mildred may deduct their IRA contributions.

Franklin may deduct his IRA contribution, but Mildred may not deduct hers.

1-55

Review Question 13

Tyler and Liz Slater, married taxpayers filing jointly, have two dependent children. Their AGI for 2013 is $350,250. What is the amount of personal and dependency exemptions that the Slaters may deduct? Neither Mildred nor Franklin may deduct an IRA contribution.

a.

$0 b.

c.

d.

$9,048 $9,360 $15,600 1-56

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAM Income Tax Planning Module 1 End of Slides

©2013, College for Financial Planning, all rights reserved.

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