FIN 221 Lecture Notes - Lecture 4: Ordinary Income, Alternative Minimum Tax, Tax Rate

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7 Feb 2017
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Chapter 4: Planning your Tax Strategy
In this world, nothing can be said to be certain except death and taxes. ~Benjamin Franklin
Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that
pattern hih est pas the treasur. There is not een a patrioti dut to inrease one’s taes. Oer and oer again the
courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it,
rich and poor alike and all do right for nobody owes any public duty to pay more than the law demands Judge Learned
Hand
Taxes and Financial Planning - the principal purpose of taxes is to finance government activities.
o Four major taxable categories:
1. Purchases:
a. Sales tax is added to the purchase price of goods
Does’t ilude food ad drugs for fiaial urde o the poor
b. Excise tax is imposed by the federal and state governments on specific goods and
services
Gasoline, cigarettes, alcoholic beverages, tires, air travel, and telephone
services
2. Property:
a. Real estate property tax is based on the value of land and buildings
Major source of revenue for local governments
b. Personal property tax assess taxes on the value of automobiles, boats, furniture,
and farm equipment
3. Wealth:
a. Estate tax is imposed o the alue of a perso’s propert at the tie of his or her
death
b. Inheritance tax is levied on the value of property bequeathed by a deceased person
Fe states do, Mihiga does’t
c. Gift tax in the value amount of $14,000 or greater
Unless it is for tuition, or medical expenses
50% tax
4. Earnings:
a. Social Security tax: FICA = Social Security (OASDI) and hospital Medicare
b. Income tax: federal, state, and local
o Importance of taxes for personal financial planning
About 1/3 of each dollar you earn goes to pay taxes
Tax Freedom Day came in mid-April and represents the portion of the year that people had to work
to pay their taxes
1. Basically January 1st to April 15th working every day, all of that income goes to taxes
o To help with many types
Know current tax laws and regulations that affect you
Maintain complete tax records
Plan purchases and investments
Income Tax Fundamentals
o Step 1: Determining Adjusted Gross Income (AGI)
Taxable income is the net amount of income after allowable deductions on which income tax is
computed.
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Types of income:
1. Earned income money received for personal effort. Earned income is usually in the form of
wages, salary, commission, fees, tips, or bonuses.
2. Investment income (sometimes referred to as portfolio income) is money received in the
form of dividends, interest, or rent from investments.
3. Passive income results from the business activities in which you do not actively participate,
such as limited partnership.
4. Other ioe = alimony, awards, lottery winnings, and prizes.
5. Exclusions an amount not included in gross income.
6. Tax exempt income that is not subject to tax.
a. Interest earned on bonds
7. Tax deferred income that will be taxed at a later date.
Adjustments to income:
Include contributions to an IRA or a Keogh retirement plan, penalties, for
early withdrawals of savings, and alimony payments.
Used as basis to calculate various income tax deductions such as medical
expenses.
EX: 401K, IRA, alimony, early withdrawal deductions, interest on student
loans
GROSS INCOME ADJUSTMENTS TO INCOME = ADJUSTED GROSS INCOME
o Step 2: Computing Taxable Income
Deductions: EXPENSES
1. Tax deduction is an amount subtracted from adjustment gross income to arrive at taxable
income.
a. Standard deduction is a set amount on which no taxes are paid.
EX: 2016 single - $6,300, MFJ - $12,600
This is deducted as a way of saying you need this much to live with basic
needs for a year
b. Itemized deductions are expenses a taxpayer is allowed to deduct from adjusted
gross income.
EX: mortgage interest, and real estate property taxes are the big two
Common deductions include:
Medical and dental expenses must be 10% of your AGI in order to
count
Taxes
Interest
Contributions to charities
Casualty and theft losses (not covered by insurance)
Moving expenses (job-related)
Job-related and other miscellaneous expenses (greater than 2% of
your AGI)
If these are more than the standard deduction (for single or MFJ) use the
itemized deductions
c. Organized financial records are important to effective/efficient tax filing.
Generally, keep tax records for 3 years
However, documentation may be required going back 6 years
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