©2015, College for Financial Planning, all rights reserved.

Session 10Income Tax Planning

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMFinancial Plan Development Course

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10-2

Differences

• Some tax preparers tell clients the consequences of what has been done within tax law.

• A planner and some tax advisors look forward and tell clients how to structure financial actions to create favorable tax consequences while achieving goals within tax law in current and future years.

• As a planner, you need to understand the basics and track changes to tax law and trends, identify strategies, and then consult clients’ tax advisors to jointly develop plan.

10-3

Tax Analysis• Analyze & evaluate client’s tax

situation

• Determine and quantify income tax planning needs

• Understand tax planning goals and philosophy

• Review past, present, and future tax planning factors, including AMT

• Document and evaluate current tax planning

• Review tax withholding

• Review use of tax-advantaged savings and debt

• Target deductions and credits

• Review prospective planning strategies

• Develop client-based recommendations

• Identify and select best strategies to meet needs

• Frame recommendations: who, what, when, where, why, how, and how much

Systematic Financial Planning

Analyze & Evaluate the Client’s Financial Status

Develop Comprehensive Plan &Present Recommendations

Implement the Plan

Monitor the Plan, Implementation,& Goal Progress

Determine and Quantify the Planning Needs

Document and Evaluate Current Planning Efforts

Establish & Define the Relationship

Gather Data &Frame Goals and Objectives

Review Prospective Planning Strategies

Develop Client-based Recommendations

Analyze Current Situation

· Identify and Select Best Strategies to Meet Need

· Frame Recommendation Into: Who, What, When, Where, Why, How and How Much

10-4

Learn the Form 1040 & Process

10-5

Using the Tax Return

Could you estimate how much money they have invested if you know current rates?

Don’t you want to know if they are a business owner or real estate investor?

10-6

Adjustments Might Be Opportunities

• Educator expenses• 3 self-employment rules:

o Deductible self-employment taxo Self-employed health insurance

premiumso Self-employed qualified plans

• Performing artists, reservists, and fee-based government officials

• Student loan interest• Student tuition and fees• Health savings accounts• Qualified moving expenses• Penalty on early withdrawal• Alimony• Deductible IRAs• Domestic production

• Not only what did they do but what COULD they do?

10-7

Itemized DeductionsLook through budget.

Ask questions.

Willingness to change?

Know tax strategies:• Bunching• Accelerating• Deferring• Shifting to others• Eligibility for state

income taxes or sales taxes

• Not all deductible for AMT!

10-8

IRA or Roth IRA - 2015IRA or Roth IRAContribution limit: $5,500Catch up: $1,000Is each a participant in a qualified plan? YES

Traditional IRA phaseout for active participants:

Married filing jointly: $98,000–$118,000

Can my clients? Can your clients?

Roth IRA phaseout:

Married filing jointly: $183,000–$193,000

Can my clients? Can your clients?

Phaseouts not provided for test – so memorize!

10-9

Deductions & Exemptions

Deductions

• Medical deduction floor for 2015: 10% (seniors 7.5% until 2016)

• Taxes

• Interest (subject to $1 million and $100k limits)

• Charity

• Casualty & theft

• Job & miscellaneous

• Other

• Phaseout 3% over $258,250 singles/$284,050 single head of household/$309,900 married filing jointly

Exemptions

• 2014: $3,950 phased out 2% for each $2,500 of AGI over phaseout limits shown above (not always provided on CFP exam)

• Know who can be claimed as dependent10-10

Alternative Minimum Tax

Common adjustments and tax preference items include:

• Personal exemptions

• Standard or certain itemized deductions (medical for seniors only & misc. itemized deductions)

• State and local income tax

• Accelerated depreciation of certain property

• Bargain element on incentive stock options

• Depletion allowances

• Intangible drilling costs

• Private activity muni-bonds (except 2009 & 2010)

• Must calculate!

10-11

AMT

• Start with line 41 (AGI after itemized deductions but before exemptions)

• Add back preference items (taxes, medical, misc. deductions, private activity bonds)

• Subtract AMT exemption subject to phaseout $83,400 (married filing jointly)

• Apply tax rate: 26%, then 28% if over $158,900 (married filing jointly)

10-12

Alt. Min. Adjustments SampleItemized Deductions What is an add-back for AMT?

10-13

Tax and CreditsThere are 7 credits: 2 children, education, foreign, energy, retirement, and other

10-14

Dudella Situation

Many changes since last year’s return:• Partial year’s wages

• Sold last of investments to fund lifestyle so have capital gains and now will have reduction in interest and dividend income

• Autumn was 17 and not working

• Tax bracket was fairly low

• No flex plan and medical expenses were subject to 10% floor

• Would like a projection since they have no clue whether they are at the right withholding

10-15

Analyze Tax Situation

Known Issues

• Client did not raise any issues other than advice for college funding

• Tax projection shows they will be significantly under-withheld by $6,025 federal and $1,062 state this year. To avoid penalties they need to pay minimum of $4,284 federal taxes (know how to calculate).

• What about future trend for withholding?

• What additional information do you need?

Why are they so under water?

1. They didn’t estimate correctly when David started his new job and he is claiming 5

2. Daughter’s age dropped off child credit since last time calculated

10-16

Dudella Recommendations

You are currently under-withholding for 2014. By claiming married 5 on David’s W-4, your taxes are going to be approximately $6,025 more than your withholdings and will incur a penalty. To avoid a penalty, you need to increase withholdings. State taxes are also under-withheld by $1,062. Options

• Increase withholdings by full amount of $4,460 per year and reevaluate in December for following year.

• Increase withholding to 90% requirement of $2,876 and use the balance to fund emergency reserves. You can pay the additional federal and state taxes owed from your savings.

• Increase contributions to qualified plans, which will reduce your taxes owed by approximately 25% for every dollar entered plus possibly impact lifetime learning tax credit.

• Borrow additional funds from the 401(k) to pay taxes or utilize IRS installment plan for 2014.

10-17

Plan Changes as We Go: Cash Flow Impact

Started with one recommendation but had to vary emergency funds due to tax under-withholding; decided not to defer purchase of life insurance until emergency funds built. You may have to adjust your plans!

Recommendation #

Debt ends

10-18

Dowler Situation

• They have a tax accountant and projection for the year

• You have projected tax consequences of portfolio transition to provide to their accountant

• They want your advice on any potential strategies

10-19

Dowler Tax ProjectionIncome Tax Calculations  

Potential Changes?

Wages $137,812

Interest $286

Dividends $4,834

Short-term capital gains $550 YES Total Income for tax purposes (line 22 on Form

1040)$143,482

Adjustments to income $0

AGI $143,482

Itemized Deduction Calculations:  

Medical over 10% $0

State taxes ($52,027)

Real estate taxes ($23,552)

Mortgage interest ($12,228) YESMisc. deductions over 2% $0

Charitable contributions ($4,396)

Total Itemized Deductions ($24,203)

Calculating Taxable Income  

Income after itemized deductions (line 41) $119,279

Subtract exemptions (3 x $4,000) ($12,000)

Taxable income after subtracting exemptions $107,279

Amount over $74,901 but under next category. This is amount to be taxed at 25%

$313,828

25% of amount over $73,800 $7,957

Plus base amount $10,312

Income Tax $18,269

Capital gains tax @15% $83

TOTAL TAX $18,352

10-20

Projection continuedAlternative Minimum Tax Add-backs  

less medical (too low—under 10%)  

less state taxes $5,027

less real estate taxes $2,552

Total of add-backs for AMT $7,579

AMT Tax Calculation  

Start with income after deductions but before personal exemptions (line 41 on Form 1040)

$119,279

Add back adjustments $7,579

AMTI $126,858

subtract AMT exemption ($83,400)

  $43,458

AMT tax multiply by rate 26% = $11,299

Compare to regular tax $18,352

if greater = difference, if lower 0 $0

Child Tax Credit $1,000 per child potential  

Start with AGI $143,482

Subtract phaseout start ($110,000)

  $33,482

ROUND UP $34,000

Multiply by 5% (.05) $1,700

Subtract from credit ($1,000)

Child tax credit Not Eligible

Other taxes N.A.

Other credits N.A.

10-21

Projection continued

• Client told you refunds consistently are ABOVE $5,000. This year will receive $5,600.

• Accountant projects $5,680

• You were told you could redirect the refunds to accomplish goals

• How much of this refund would you redirect? What are the risks of taking too much?

• Use 90% or less with understanding that there could be some taxes owed or some refund. (This is already in your cash flow template at $5,000!)

• You are making changes to their picture that you don’t know the impact of yet.

Total Due $18,352

Taxes withheld - Jim ($16,672)

Taxes withheld - Anne ($7,360)

Total withheld ($24,032)

Amount Due $18,352

Projected Refund for this year ($5,680)

Colorado State Tax 4.63%  

Start with Taxable Income $107,279

Add back state taxes $5,227

Colorado taxable income $112,506

  *.0463

 Projected State Tax $5,209

Projected State Refund $18

10-22

Concerns & OpportunitiesAre you planning any strategies that could impact these issues?

If I put an extra $14,000 in qualified plans and $1,500 in flex plans, would they qualify for child tax credit?

If I sold annuity and life insurance and had cap gains, would it put them in AMT?

Your plans have an impact. Think it through!

10-23

Plan Development Box #17

10-24

Flexible Spending Accounts

• 2015 maximum of $2,550 per employee.

• Grace periods or “rollover” of $500 (employer must adopt as part of plan – your client’s plan has done this) OR allow first 2½ months to submit expenses.

• Reduces GROSS income so federal, state, and FICA savings: 25% + 4.63% + 7.65% = 37.28% savings!

• Your clients told you they are averaging $1,300 out of pocket on copays and deductibles now.

• What other expenses may be deductible?

10-25

Plan Development Box #18

10-26

Gifting Appreciated Stock to Charity

• Charity won’t pay tax on sale, but if you retain you will at some point in the future

• Great way to consistently rebalance portfolio

• Even if you don’t need to rebalance, you can buy back SAME stock without wash rules

• Impact on cash flow ONLY to extent this was going to create gains; this avoids gains but won’t create a positive cash flow

• Not good for small donations

• Rules different for short-term vs. long-term gain

Disadvantages:

• Potential transaction costs

• Potential timing issues in rebuying or gifting

• Emotional charge of writing a check on the spot

10-27

Gifting: Short- vs. Long-Term Holding Period

Short-Term Holding

•No tax paid on gain at transfer

•No restrictions on repurchase

•Charitable deduction limited to basis

Long-Term Holding

•No tax paid on gain at transfer

•No restrictions on repurchase

•Charitable deduction for full transferred amount

10-28

What would the savings be?

1. Clients normally gift $10,000 to church consistently.2. Client has investment to reposition this year.3. Long-term capital gains rate is 15% federal, 6% state.

Stock 2Value: $10,000Basis: $3,000Holding period: 2 yearsGain: $7,000Tax if ALL sold: $1,470Tax if gifted: 0Consistently used can result in significant savings!

10-29

Plan Development Box #19

10-30

Next Class

10-31

©2015, College for Financial Planning, all rights reserved.

Session 10End of Slides

CERTIFIED FINANCIAL PLANNER CERTIFICATION PROFESSIONAL EDUCATION PROGRAMFinancial Plan Development Course