Chapter 4:
Managing Taxes
Objectives
• Describe the two ways of paying taxes: payroll withholding and
estimated taxes.
• Identify the three steps involved in calculating federal income taxes.
• Understand planning strategies to legally avoid overpayment of
income taxes.
• Explain the basics of IRS audits.
Taxes on Purchases
• State and local taxes are added to the purchase price of goods.
• Excise tax is imposed on specific goods and services
•
•
•
•
•
•
Gasoline
Cigarettes
Alcohol
Tires
Air travel
Telephone service
Taxes on Property
• Real estate property tax is based on the value of land and buildings.
• Personal property taxes on the value of automobiles, boats, furniture,
and farm equipment are imposed in some areas.
Administration/Classification of Income Taxes
• Federal tax laws
• Marginal tax rate
• Progressive nature
of income tax
• Effective marginal
tax rate
• Regressive
• Average tax rate
New Math
Taxes on Wealth
• Estate tax-federal tax imposed on the value of an individual’s property
at the time of death.
• Inheritance tax-state tax levied on the value of property bequeathed
by a deceased individual.
3 Steps in Determining Taxes
1. Determining Adjusted Gross Income
2. Computing Taxable Income
3. Calculating Taxes Owed
What is Tax Management?
ATTENTION!
A PLANNING PROCESS FOR TAX:
• Reduction
• Deferment
• Elimination
Total Income Tax Bracket
Federal Income
Tax Bracket
+ State Income Tax Bracket
(Federal Income
Tax Bracket
x
State Income
Tax Bracket)
Example:
Mike’s federal income tax bracket is 28% and his state income tax bracket is 7%. What is
Mike’s total income tax bracket?
28% + 7% - (28%x7%)
= .28+.07 - (.28 x .07)
= .35 - .0196
= .33 or 33%
Step 1: Determining Adjusted Gross Income (AGI)
Earned Income-money received by personal effort.
Investment Income-money received in the form of dividends,
interest, or rent
Passive Income-activities in which you do not actively
participate.
Other Income-Alimony, awards, lottery winning, prizes
Other Items That Impact Income
Exclusion-amount not included in gross income.
Tax Exempt Income-another name for exclusions-Qualified
scholarships and fellowships where money is used for tuition,
fees, supplies, and equipment, VA payments
Tax Deferred Income-income that will be taxed at a later date
Adjusted Gross Income (AGI)-gross income after certain
reductions have been made
Tax Shelters-immediate tax benefits and a reasonable
expectation of a future financial return (IRA’s Keogh’s)
Taxes on Earnings
• Social Security
• Income Tax
• Federal tax
• State tax in all but 7 states
•
•
•
•
•
•
•
Alaska
Florida
Nevada
South Dakota
Texas
Washington
Wyoming
2014 Federal Tax Rate Schedules
Single
If taxable income is over—
but not over—
the tax is:
$0
$9,075
10% of the amount over $0
$9,075
$36,900
$907.50 plus 15% of the
amount over $9,075
$36,900
$89,350
$5,081.25 plus 25% of the
amount over $36,900
$89,350
$186,350
$18,193.75 plus 28% of the
amount over $89,350
$186,350
$405,100
$45,353.75 plus 33% of the
amount over $186,350
$405,100
$406,750
$117,541.25 plus 35% of the
amount over $405,100
$406,750
no limit
$118,118.75 plus 39.6% of
the amount over $406,750
The Marginal Tax Rate Affects Your Final Decision
$3,950 personal exemption is not taxed
$6,200 standard deduction is not taxed
Next $9,075 of income is taxed at 10%
Remaining
$42,950 of income
is taxed at 25%
Next $27,825 of income is
taxed at 15%
0
+
0
+
$835.00 +
$3,840.00
+
$4,175
Gross Income = $90,000
Taxable Income = $79,850
Taxes = $15,819
Marginal Tax Rate = 25%
Average Tax Rate = 19.8% (Taxes Paid / Taxable Income)
How We Pay Taxes
Eight Steps in Calculating Your Income Taxes
Step 1
Total Income
Step 2
Gross Income
Step 3
Adjusted Gross Income
Step 4
Subtotal
Step 5
Taxable Income
Subtract
exclusions
Subtract adjustments
to income.
Subtract standard deduction or
total itemized deductions.
Subtract value of exemptions
Step 6
Apply tax table or tax-rate schedule to determine
liability.
Step 7
Final tax liability
Step 8
Calculate balance owed or
refund.
Subtract tax credits
Step 2: Computing Taxable Income
Deduction-an amount subtracted from AGI to
arrive at taxable income.
• Standard deduction ($6,200/single in 2014)
• Itemized deduction
Exemption-a deduction from AGI for yourself,
your spouse, and qualified dependents
($3,950 in 2014)
Step 3: Calculating Taxes Owed
• Use your taxable income in conjunction with the
appropriate tax table or tax schedule.
• Marginal tax rate-the tax on the last dollar of
income.
• Average tax rate-total tax due divided ty your
taxable income.
• Tax credit-amounts subtracted from the amount of
tax owed.
Who Should File a Tax Return?
STUDENTS WITH:
• Earned income
• Unearned income
• Transfer payments
Which Tax Form Should I Use?
Form 1040EZ is the simplest form to fill out. You may use Form 1040EZ if you meet all the following conditions:
1.Your filing status is single or married filing jointly
2.You claim no dependents
3.You, and your spouse if filing a joint return, were under age 65 on January 1, 2015, and not blind at the end of 2014
4.You have only wages, salaries, tips, taxable scholarship and fellowship grants, unemployment compensation, or Alaska Permanent Fund
dividends, and your taxable interest was not over $1,500
5.Your taxable income is less than $100,000
6.Your earned tips, if any, are included in boxes 5 and 7 of your Form W-2
7.You do not owe any household employment taxes on wages you paid to a household employee
8.You are not a debtor in a Chapter 11 bankruptcy case filed after October 16, 2005
9.You do not claim any adjustments to income
10.You do not claim any credits other than the earned income credit
11.Advance payments of the premium tax credit were not made for you, your spouse, or any individual you enrolled in coverage for whom no one
else is claiming the personal exemption
If you file Form 1040EZ, you cannot itemize deductions or claim any adjustments to income or tax credits (other than the earned income credit).
Which Tax Form Should I Use?
If you cannot use Form 1040EZ, you may be able to use Form 1040A if:
Your income is only from wages, salaries, tips, taxable scholarships and fellowship grants, interest, ordinary
dividends, capital gain distributions, pensions, annuities, IRAs, unemployment compensation, taxable Social Security
or railroad retirement benefits, and Alaska Permanent Fund dividends
Your taxable income is less than $100,000
You do not itemize deductions
You did not have an alternative minimum tax adjustment on stock you acquired from the exercise of an incentive
stock option
Your only adjustments to income are the IRA deduction, the student loan interest deduction, the educator expenses
deduction, the tuition and fees deduction, and
The only credits you are claiming are the credit for child and dependent care expenses, the earned income credit, the
credit for the elderly or the disabled, education credits, the child tax credit, the additional child tax credit, or the
retirement savings contribution credit
If line 43
(taxable
Income) is
And you are --
At least
But less
than
Single
Married
Filing
Jointly
Married
Filing
Separately
26,000
26,050
3,450
2,996
3,450
Head of
A
HouseHold
3,256
26,050
26,100
3,458
3,004
3,458
3,264
26,100
26,150
3,465
3,011
3,465
3,271
26,150
26,200
3,473
3,019
3,473
3,279
26,200
26,250
3,480
3,026
3,480
3,286
26,250
26,300
3,488
3,034
3,488
3,294
26,300
26,350
3,495
3,041
3,495
3,301
26,350
26,400
3,503
3,049
3,503
3,309
Tax Credit Versus Tax Deduction
• $100 tax credit reduces your taxes by $100
• $100 tax deduction reduces taxes by your tax bracket.
For instance, if a person is in the 25% tax bracket it
would reduce your taxes by 25%
Is it Taxable Income? Is it Deductible?
Is it Taxable Income?
Yes
No
Is it Deductible?
Lottery Winnings
Life Insurance Premiums
Child Support Received
Cosmetic Surgery for
Improved Looks
Worker’s Compensation
Benefits
Fees for Traffic Violations
Life Insurance Death
Benefits
Mileage for Driving to
Volunteer Work
Municipal Bond Interest
Earnings
An Attorney’s Fee for
Preparing Will
Bartering Income
Income Tax Preparation
Yes
No
Is it Taxable Income? Is it Deductible?
Is it Taxable Income?
Lottery Winnings
Yes
No
Is it Deductible?
x
x
Cosmetic Surgery for
Improved Looks
x
Fees for Traffic Violations
x
x
Worker’s Compensation
Benefits
X
Life Insurance Death
Benefits
x
Mileage for Driving to
Volunteer Work
Municipal Bond Interest
Earnings
x
An Attorney’s Fee for
Preparing Will
x
No
Life Insurance Premiums
Child Support Received
Bartering Income
Yes
Income Tax Preparation
x
x
x