Chapter 4:
Managing Taxes
Objectives
• Explain how taxes are administered and
classified.
• Describe the concept of the marginal tax
rate.
• Determine who should file an income tax
return.
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
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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.
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
Administration/Classification of Income Taxes
• Federal tax laws
• Marginal tax rate
• Progressive nature
of income tax
• Effective marginal
tax rate
• Regressive
• Average tax rate
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 7.65%
Income Tax
• Federal tax
• State tax in all but 7 states
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Alaska
Florida
Nevada
South Dakota
Texas
Washington
Wyoming
The Marginal Tax Rate Affects Your Final
Decision
$3,650 personal exemption is not taxed
$5,700 standard deduction is not taxed
Next $8,350 of income is taxed at 10%
Remaining
$16,700 of income
is taxed at 25%
Next $25,600 of income is
taxed at 15%
0
+
0
+
$835.00 +
Gross Income = $60,000
Taxes = $8,850
Marginal Tax Rate = 25%
$3,840.00
+
$4,175
State, Local and Total Income Tax
Bracket
Total Income Tax Bracket =
Federal + State – (Federal x State)
Mike’s federal tax bracket is 28% and
his state income tax bracket is 7
percent. His total income tax bracket is:
28% + 7% - (28% x 7%)
=.35 -.02
= .33 or 33%
Adjusting Interest Rates
After Tax Interest Rate =
Interest Rate x (1- Marginal Tax Rate)
If you pay 10% interest on a $1,000 loan your interest
payment is $100. But if that interest is deductible and
you’re in the 28% tax bracket, you save 28% of $100 or
$28 in taxes. So, counting your tax savings, you’ve
paid only $72 in after tax interest or 7.2% of $1,000.
.10 x (1-.28)
= .10 x .72
=.072 or 7.2%
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 ($5,700/single in
2010)
• Itemized deduction
Exemption-a deduction from AGI for
yourself, your spouse, and qualified
dependents ($3,650 in 2010)
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.
The Progressive Nature of the Federal Income
Tax-2010
If your filing status is Single
If your taxable income is:
Over:
But not
over --
The tax is:
Of the
amount
over--
$0
$8,350
------------ 10%
$0
8,350
33,950
$835.00 + 15%
8,350
33,950
82,250
4,675.00 + 25%
33,950
82,250
171,550
16,750.00+ 28%
82,250
171,550
372,950
41,754 + 33%
171,550
372,9650
----------
108,216 + 35%
372,950
The Tax Rate Schedule is shown so you can see the tax rate that applies to all levels of taxable income. It is not used to figure
ones’ taxes.
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%
Who Should File a Tax Return?
STUDENTS WITH:
• Earned income
• Unearned income
• Transfer payments
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