chapter 3. learning objectives (part 1 of 2) describe the basic federal tax model distinguish...

Chapter 3

Learning Objectives (part 1 of 2) Describe the basic federal tax model Distinguish between adjustments to

income and itemized deductions Determine the economic value of an

itemized deduction Compute the tax liability for any filing

status and level of taxable income Determine a person's marginal tax rate

Learning Objectives (part 2 of 2) Decide how much in federal taxes you

will withhold on your paycheck Determine the tax impact of a capital

gain or a capital loss Discuss some of the differences in

taxation among the various states Understand the likelihood of having

your tax return audited Know how to do your own research on a

tax question

How is taxable income computed?

Total Income - Adjustments to Gross Income = Adjusted Gross Income or AGI - Standard Deduction or Itemized

Deductions (whichever is larger) -Personal Exemptions = Taxable Income

How is the tax refund or payment due computed?Based on your taxable income, determine

your tax liability, then  Tax liability - Credits + Other taxes owed= Total taxes for the year - Taxes paid to date = Taxes Refund to be received or tax due

What is included in gross income? (part 1 of 2) Wages Salaries taxable interest ordinary dividends business income (or loss)

What is included in gross income? (part 2 of 2) capital gain (or loss) taxable portion of total pensions

and annuities alimony received taxable portion of Social Security

benefits.

What are the adjustments to gross income? (part 1 of 2) IRA deduction student loan interest deduction moving expenses (when they

qualify)

What are the adjustments to gross income? (part 2 of 2) Keogh contributions self-employed SEP and SIMPLE

plan contributions alimony paid

What are the filing statuses and the standard deductions (for 2000) for each category?

Single $4,400Head of Household 6,450Married filing jointly 7,350Married filing separately 3,675

Surviving spouse 7,350

What are the itemized deductions categories? (part 1 of 2)

Medical and dental expenses (only to the extent they exceed 7.5% of AGI)

Taxes Interest expenses Gifts to Charity (not to exceed 50%

of AGI)

What are the itemized deductions categories? (part 2 of 2)

Casualty and theft losses (reduced by $100 per event, and only to the extent they exceed 10% of AGI)

Job related expenses and most miscellaneous deductions (only to the extent they exceed 2% of your AGI)

Miscellaneous Deductions

How do Itemized Deductions affect Taxable Income? If the taxpayer does not itemize

=> No change (even those things that claim to be tax deductible

If the taxpayer does itemize => Taxable Income reduced only by the amount itemized deductions exceed the standard deduction for the filing status

Exemptions Automatic exemption for one’s

self, unless declared as an dependent on another’s tax return

Spouse (if married filing jointly) One for each dependent (must

show Social Security number)

Marginal Tax Rate Rate at which any incremental

income is taxed The relevant tax rate to use for

most decision making purposes (except where income such as capital gains is taxed at a different rate

Are there tax breaks for educational expenses? Might qualify as itemized deduction

(subject to 2% rule) if required by an employer to keep a job

Hope Credit (under certain conditions, up to $1,500 per year)

Lifetime learning credit (under certain conditions, up to $1,000 credit)

How much withholding should I claim? 3 strategies Over withhold (forced savings) Target exact amount due Under withhold (but not enough to

trigger interest or penalties)

Capital Gains and Capital Losses (part 1 of 2) Gain or loss = Selling proceeds

(less commissions) – Cost basis (net of commissions)

One year divides short term from long term

Gains and losses are matched against each other

Capital Gains and Capital Losses (part 2 of 2) Gains taxed at CG tax rate (20% or

10%) losses written off (up to $3,000 per

year) Personal assets such as cars are

only subject to capital gain rules Homes may be exempt from capital

gains rules under certain conditions

What increases the chances of being audited? High income Self-employed Deductions exceed guideline

amounts (known only to IRS) Employed in job associated with

tendency to underreport Live in a sparsely populated state

How do state income taxes affect my marginal tax rate? State income taxes are not taken as an

itemization on one’s federal tax return:

MTRcombined = MTRfederal + MTRstate.

State taxes are itemized on the federal return:

MTRcombined = MTRfederal+ MTRstate x (1 – MTRfederal).