Chapter 4
Lecture 3
Tax Planning and Strategies
Individual Income Tax Formula
Total Income (everything received)
- Exclusions/Tax-exempt Income_______________
= Gross income (GI)
- Adjustments______________________________
= Adjusted Gross Income (AGI)
- Greater of Standard or Itemized deductions
- Personal and dependency Exemptions ($3050 in
2003)__________________________________
= Taxable income (TI)
* Tax rates: 10%-35%______________________
= Tax liability
- Tax credits
- Tax prepayments___________________________
= Tax due or refund
Calculating Adjusted Gross
Income (AGI)
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Adjustments for AGI include:
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Alimony payments.
Moving expenses.
50% of FICA taxes (social security and Medicare) if selfemployed.
100% of health insurance costs if self-employed.
Payments to a Keogh or SEP retirement plan.
Payments to a Traditional IRA.
Student loan interest.
Tuition and fees.
IRAs

Traditional IRA:
Contributions are deductible (limited to $4,000 per
year).
 Contributions and earnings are taxed when money is
withdrawn.
 Limits if covered by an employer-sponsored plan or
if income exceeds a certain amount.
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IRAs
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Roth IRA:
Contributions are not deductible.
 Can contribute up to $4,000 per year.
 Individuals whose income exceeds specified
limits are not eligible for a Roth IRA.
 Contributions and earnings are not taxed when
money is withdrawn.
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Student Loan Interest
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Student loan interest paid is an adjustment to gross
income.
Can deduct up to $2,500 per year.
There is a phase-out of the amount of the adjustment
based on income levels.
Tuition and Fees
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Adjustment for qualified tuition and fees paid.
Limit is $4,000 per year.
Cannot take adjustment in same year claiming a
Hope or lifetime learning credit.
Subtracting Deductions from AGI
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Take the greater of:
 The standard deduction or the total itemized
deductions.
Standard Deduction
for 2005
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Single -- $5,000.
Married filling jointly -- $10,000.
Married filing separately -- $5,000.
Head of household -- $7,300.
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Note: thresholds are indexed for inflation
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Itemized Deductions
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Medical and dental expenses paid (must exceed 7.5% of
AGI).
Taxes paid (state income, real estate, and personal
property taxes such as vehicle ownership tax).
Interest paid (e.g., home mortgage interest).
Charitable contributions (cash and noncash).
Miscellaneous itemized (must exceed 2% of AGI).
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Tax preparation fees and safe deposit expense.
Phase-Out of Itemized
Deductions
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Taxpayers in higher income brackets do not get credit
for all their itemized deductions.
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2005 married filing jointly – AGI of $145,950.
Lose deductions equal to 3% of the amount by which your
AGI exceeds this amount.
Always can take the standard deduction.
The phase-out of itemized deductions will begin to be
eliminated in 2006, disappearing entirely by 2010.
Classification of Deductible
Items
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Adjustments are “above the line.”
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See page 1 of Form 1040.
Deductions (standard or itemized) are “below
the line.”
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See page 2 and Schedule A of Form 1040.
Claiming Your Exemptions
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Exemptions are given so that everyone will have a little
bit of untaxed money to spend on necessities.
Is a deduction for each person supported by the
income on your tax return.
Exemptions
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Two types:
Personal exemption (yourself) – $3,200.
 Dependency exemption - $3,200 each.
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Must pass a relationship or household member test.
 You must provide more than half of the dependent’s
support.
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Are subject to phase-outs (exemptions can be
reduced to $0).
Phase-out of Exemptions
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Once AGI reaches a certain level, the value of
the exemptions taken is reduced
 2005 – married filing jointly $218,950
(reduction when AGI exceeds this
amount).
 For every $2,500 your AGI exceeds this
amount, you lose 2% of your exemptions.
Calculating Your Income Tax
Liability
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Tax Table.
Tax Rate Schedules -- must be used if taxable
income exceeds $100,000.
Alternative Minimum Tax (AMT) -- parallel tax
system designed to prevent the very wealthy
from using the tax breaks to pay little or no tax.
Schedule Y-1 — Married Filing
Jointly or Qualifying Widow(er)
If taxable income is over-
But not over--
The tax is:
$0
$14,600
10% of the amount over $0
$14,600
$59,400
$1,460.00 plus 15% of the amount over 14,600
$59,400
$119,950
$8,180 plus 25% of the amount over 59,400
$119,950
$182,800
$23,317.50 plus 28% of the amount over 119,950
$182,800
$326,450
$40,915.50 plus 33% of the amount over 182,800
$326,450
no limit
$88,320.00 plus 35% of the amount over 326,450