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Tax Planning
Updated 9/11/2012
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Objectives
A. Understand the principles of tax planning B. Understand the importance of tax planning and how it helps attain your personal goals C. Understand the tax process D. Understand strategies to help lower your taxes (legally and honestly) E. Understand the major tax features of our tax system
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Action Plan:
What Tax Form and Tax Strategies should you use this year? What else can and should you do to reduce your tax bill to Uncle Sam (for a given level of income)?
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Questions
Any questions about what our leaders have said about paying taxes?
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B. Understand How Tax Planning can help Attain your Personal Goals
Why tax planning?
Taxes are your largest single annual expense The average American works more than 4 months just to pay his or her taxes In sum: the less you pay Uncle Sam (for a given level of income), the more you have for your personal and financial goals!
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Source: Tax Foundation, Washington, D.C., http://www.taxfoundation.org/taxfreedomday/ January 18, 2012.
Estate Planning
Taxes
Retirement Planning
Investing
Insurance
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Questions
Any questions on the impact of taxes and your personal goals?
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2. Subtract Adjustments to Gross Income (for AGI deductions) = Adjusted Gross Income (AGI)
5. Look up tax on tax table (tax = taxable income times tax rate) = Tentative Tax
Definitions
1. Gross Income
Gross income for tax purposes is all income, unless specifically excluded or deferred Exclusions include certain employer provided fringe benefits and contributions, contributions to qualified retirement accounts, gifts and inheritances, life insurance proceeds, grants not in excess of college expenses, municipal bond interest, and interest for education savings vehicles used for education Deferrals include like-kind exchanges
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Definitions (continued)
2. Adjustments
Adjustments are deductions from total income allowed by the IRS to get your Adjusted Gross Income (AGI). These include (among others): Qualified medical savings contributions (flexible spending accounts) Contributions to individual retirement accounts (IRA) Contributions to Health Savings Accounts (HSAs) Student loan interest and tuition and fees deduction (IRS 970) (within limits) One-half self employment tax, etc. Losses include net capital losses (up to $3,000), sole proprietorship losses, and active participation real estate losses
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Definitions (continued)
3. Standard Deductions
Deductions are IRS allowed reduction amounts (standard deduction) or taxpayer determined amounts (itemized deductions) to get taxable income from your AGI Year Standard Deduction (MFJ) 2008 $10,900 2009 11,400 2010 11,400 2011 11,600 2012 11,900
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Definitions (continued)
3. Itemized Deductions
Allowable deductions (if you itemize) include: Charitable contributions (cash, in kind, and/or mileage) Home mortgage interest Medical expenses (>7.5% AGI), Un-reimbursed qualified job expenses (> 2% AGI), Casualty and theft expenses (> 10% AGI), Either state and local taxes or state and local general sales taxes, property taxes on principle residence, etc.
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Definitions (continued)
Mileage deduction vary depending on usage: Charitable mileage deductions 2010 .140 per mile 2011 .140 per mile 2012 .140 per mile Business mileage deductions 2010 .500 per mile 2011 .510 per mile 2012 .550 per mile Moving or medical mileage expense deductions 2010 .165 per mile 2011 .190 per mile 2012 .230 per mile
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Definitions (continued)
4. Exemptions
An exemption is an amount of money set by the government that you can deduct for each qualifying person in your household. If you are married with 4 young children still at home, you have 6 exemptions Year Exemption Amount ($) 2008 3,500 2009 3,650 2010 3,650 2011 3,700 2012 3,800
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Definitions (continued)
5. Tax Tables (married filing jointly [Schedule Y-1])
Year If Taxable income is over 2010 0 $16,750 $68,000 $137,300 2011 $0 17,000 69,000 139,350 2012 0 17,400 70,700 142,700 But not Tax over is $16,750 0 $68,000 1,675 $137,300 9,363 $209,250 26,688 $17,000 $0 69,000 1,700 139,350 9,500 212,300 27,088 17,400 0 70,700 1,740 142,700 9,735 217,450 27,735 Plus this Of the percentage Excess 10% 0 15% 16,750 25% 68,000 28% 137,300 10% $0 15% 17,000 25% 69,000 28% 139,350 10% 0 15% 17,400 25% 70,700 28% 142,700
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Definitions (continued)
6. Credits
Credits are dollar for dollar reductions in your taxable liability. Credits are worth significantly more than deductions. Credits are either refundable (paid to the taxpayer even if the amount of the credits exceeds the tax liability) or non-refundable Refundable credits include reductions for earned income, taxes withheld on wages, estimated income tax payments Non-refundable credits include child tax, child and dependent care, elderly and disabled, adoption, hope learning, and lifetime learning
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Definitions (continued)
Tax Credits for Students (income limits apply)
Earned Income Tax Credit. This is available to low-income individuals (age 24 and over) American Opportunity Tax Credit. Temporary credit, which provides up to $2,500, 100% of the first $2,000 and 25% of the next $2,000 Lifetime Learning Credit. You can get up to $2,000, 20% of the first $10,000 of expenses, even if you are part-time Tuition and Fees Deduction. You may also claim an education tax deduction instead of a college tuition tax credit, up to $4,000 off your income
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Have a folder that you put all your tax receipts into for tax timekeep it current Use an electronic system such as Quicken or Mint.com to organize your finances These programs make taxes easier if you use them as they help you remember when and where you made tax-deductible contributions
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Use prior years returns as examples for your current years return Make sure you take the same deductions each yearor at least be aware of them Keep prior years returns for 7 years, including returns and backup for key deductions and credits
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Keep good records so you can itemize deductions, including charity, insurance, and other key areas Get good at showing what non-cash charitable contributions you make, such as miles you travel for church or scout related activities. These can be deducted at 14 cents per mile in 2012 Keep records of the non-cash donations you give to Deseret Industries, Salvation Army, etc. as these can be deducted if you itemize
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4. Spend time in December estimating capital gains, and offset them if possible with capital losses
Offset capital gains with capital losses to manage your investment income You can deduct up to $3,000 per year in capital losses (every little bit helps) in 2012
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5. Pay your tithes and offerings with appreciated long-term capital assets (if you have
them). If you donate appreciated assets instead of selling them, you do not have to pay the capital gains on those assets Donate the appreciated assets directly to the charities of your choice For an example of paying tithing and other offerings with appreciated assets, see Learning Tool 8: Tithing Share Transfer Example
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Questions
Any questions on legal ways to reduce your tax bill?
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1. Income Taxes
Income taxes
Progressive tax meaning that the more you earn the more you pay Marginal tax rate Percentage of the last dollar that you earned that will go toward federal income taxes Average tax rate Average amount of every dollar you earned that was paid for federal income taxes Effective marginal tax rate Average amount of every dollar you earned that paid for all local, state, and federal income taxes
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Questions
Any questions on the major tax features of our tax system?
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Review of Objectives
A. Do you understand what our leaders have said regarding taxes? B. Do you understand the importance of tax planning and how it helps attain your personal goals? C. Do you understand the tax process and strategies to help lower your taxes? D. Do you understand the major tax features of our tax system?
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Case Study #1 Data: Matt and Janina, ages 42 and 40, are married and filling out their 2012 taxes. They
have 4 children, 3 under 17 and one a dependent in college. They contributed $5,000 to a traditional 401k in 2012, and $2,500 to a flexible spending plan. They can only deduct medical bills above 7.5% of AGI, and job related expenses above 2% of your AGI. Exemptions are $3,800 per person, the standard deduction for married filing jointly is $11,900, and the child tax credit is $1,000 per child under 17. Tax rates for 2011 for married filing jointly are: $0 to $17,400 10% $17,400 to $70,700 $1,740 plus 15% of the amount over $17,400 $70,700 to $142,700 $9,735 plus 25% of the amount over $70,700 Income: Earned Income $80,000 Interest Income 10,000 Expenses: Home mortgage interest 6,800 Un-reimbursed medical bills 7,000 Un-reimbursed Job-related expenditures 2,000 Tithes and offerings 9,600 Calculations: Using the married filling jointly status and the information above, calculate their taxes first using the standard deduction and then using itemized deductions. Calculate their marginal tax rate and average tax rate on gross income. Recommendations: Which way should they calculate their taxes? What could they do 41 41 41 to reduce their taxes?
Married with 4 children, 3 under 17; Tax rates: 0 to $17,400, 10%; $17,400 to $70,700, $1,740 plus 15% of the amount over $17,400; $70,700 to $142,700, $9,735 plus 25% of the amount over $70,700. Earned Income $80,000, Interest Income 10,000, traditional 401k 5,000, Flexible Spending Plan 2,500, Home mortgage interest $6,800, Un-reimbursed medical bills 7,000, Unreimbursed job-related expenditures 2,000, Tithing 9,600. Can only deduct medical bills above 7.5% of AGI and job related expenses above 2% of AGI. Exemptions $3,900 per person, standard deduction $11,900, and child tax credit $1,000 per child under 17.
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Married with 4 children, 3 under 17; Tax rates: 0 to $17,400, 10%; $17,400 to $70,700, $1,740 plus 15% of the amount over $17,400; $70,700 to $142,700, $9,735 plus 25% of the amount over $70,700. Earned Income $80,000, Interest Income 10,000, traditional 401k 5,000, Flexible Spending Plan 2,500, Home mortgage interest $6,800, Un-reimbursed medical bills 7,000, Un-reimbursed job-related expenditures 2,000, Tithing 9,600. Can only deduct medical bills above 7.5% of AGI and job related expenses above 2% of AGI. Exemptions $3,900 per person, standard deduction $11,900, and child tax credit $1,000 per child under 17.
Married with 4 children, 3 under 17; Tax rates: 0 to $17,400, 10%; $17,400 to $70,700, $1,740 plus 15% of the amount over $17,400; $70,700 to $142,700, $9,735 plus 25% of the amount over $70,700. Earned Income $80,000, Interest Income 10,000, traditional 401k 5,000, Flexible Spending Plan 2,500, Home mortgage interest $6,800, Un-reimbursed medical bills 7,000, Un-reimbursed job-related expenditures 2,000, Tithing 9,600. Can only deduct medical bills above 7.5% of AGI and job related expenses above 2% of AGI. Exemptions $3,900 per person, standard deduction $11,900, and child tax credit $1,000 per child under 17.
Calculations: Itemized Deduction Method 1. Gross Income (Earned + Interest 401k deferral) $85,000 less Flexible Spending -2,500 2. Adjusted Gross Income 82,500 3. Deductions Home Mortgage Interest 6,800 Medical Expenses 813 (7,000-(82,500*.075) Job-related Expenditures 350 (2,000-(82,500*.02) Tithing 9,600 Total Deductions 17,563 4. Minus Income Exemptions 22,800 (6 ex.) Equals Taxable income 42,183 5. Look up Tax in Table 1,740 10% on first $17,400 3,711 15% on remainder Calculated tentative tax $5,451 6. Child tax credit -3,000 (1,000 * 3 kids under 18) 7. Total Taxes Due $2,451
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Married with 4 children, 3 under 17; Tax rates: 0 to $17,000, 10%; $17,000 to $69,000, $1,700 plus 15% of the amount over $17,000; $69,000 to $139,350, $9,500 plus 25% of the amount over $69,000. Earned Income $80,000, Interest Income 10,000, traditional 401k 5,000, Flexible Spending Plan 2,500, Home mortgage interest $6,800, Un-reimbursed medical bills 7,000, Un-reimbursed job-related expenditures 2,000, Tithing 9,600. Can only deduct medical bills above 7.5% of AGI and job related expenses above 2% of AGI. Exemptions $3,700 per person, standard deduction $11,700, and child tax credit $1,000 per child under 17.
Calculations: Calculate their marginal and average tax rate on gross income.
Their marginal tax rate, the tax rate they would pay on each new dollar of income is 15% for both the standard and itemized deduction calculation Their average tax rate, the rate they actually pay in taxes is their taxes divided by their gross income. Standard deduction = 3,300 / 85,000 = 3.9% Itemized deduction = 2,451 / 85,000 = 2.9%
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Case Study #2
Data Your friend Brian, a financial analyst, comes to you with this sure-fire method of reducing taxes. He says that if you buy into this product (this product can be many different types of tax-schemes), you will not have to pay taxes on the earnings and it will save you taxes as well. It doesnt sound right, so Brian comes and asks: Application To what lengths should you go to avoid taxes? Where should your best tax advice come from?
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Any legal method. However, if it seems to good to be true, it probably is, so get another opinion. Its not worth losing your integrity or going to prison over bad tax advice. You are ultimately responsible for your choices and for paying taxes. Where you get your tax advice, and how and what you pay for your taxes and other obligations is your choice. Your best tax advice should come from those who make it a business of giving tax advice. In addition, the IRS has many publications which can help you as you determine the taxes you should pay.
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