Dealing with Your Federal Income Tax

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Dealing with Your Federal Income Tax

• The Definitions
• AGI Adjusted Gross Income
• Taxable Income or Net Income Income on which
  tax is computed, or ones gross income minus
  deductions and exemptions

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Main Components of Gross Income

• Earned income
• Usually includes wages, salary, commissions,
  fees, tips or bonuses (W-2s) (1099 MISCs)
• Investment income
• Money received in the form of dividends,
  interest, capital gains or rent from investments
  (1099 INTs, 1099 DIVs, 1099 MISCs, 1099 Bs)
• Passive income
• Results from business activities in which you do
  not directly participate such as a limited
  partnership (Usually Sched K-1s)
• Other income
• Alimony, awards, lottery and gambling winnings,
  and prizes

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Total income is affected by

• Exclusions
• Amounts allowed by law to be excluded from gross
  income
• Some items referred to as tax-exempt income or
  income not subject to federal income tax
• Example interest on most state and city bonds
• Tax-deferred income
• Income that will be taxed at a later date, such
  as earnings from an traditional individual
  retirement account (IRA)

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Adjusted Gross Income

• Adjustments to income
• Reduce Gross Income to Adjusted Gross Income
• Contributions to a traditional IRA or Keogh
• Alimony payments
• Interest on a Student Loan
• One half of your Self- Employment Tax
• Adjusted gross income (AGI)
• Gross income reduced by these certain reductions
• Becomes the basis for computing various other
  deductions on Schedule A

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Calculate Taxable Income

• Tax deduction Amount subtracted from adjusted
  gross income (AGI) to arrive at taxable income
  before ones exemptions
• Use the Standard deduction (2011)
• Single - 5,800 Joint - 11,600
• Head of Household - 8,500
• (Most people use the standard deduction)

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Calculate Taxable Income - Itemized Deductions

• Medical dental expenses (Greater than 7.5 of
  AGI)
• Taxes (State Local)
• Home Interest
• Charitable Contributions
• Casualty and theft loses (Greater than 10 of AGI
  plus 100 for each occurrence)
• Moving expenses
• Job-related expenses
• Other miscellaneous expenses (Most have to be
  greater than 2 of AGI some such as gambling
  losses do not.)

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Calculate Taxable Income Exemptions

• Exemptions ? Subtracted from AGI less deductions
• An exemption a deduction for yourself, your
  spouse and qualified dependents
• The amount of the exemption for the 2011 tax
  year is 3,700 per person
• After deducting exemptions you have arrived at
  your taxable income

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Calculate Taxes Owed

• Tax table rates Marginal rates
• The tax rate paid on the last (or next) dollar of
  taxable income.
• Example
• After deductions and exemptions, a person in the
  25 tax bracket pays 25 cents in federal income
  taxes for every dollar of taxable income in that
  bracket.

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2011 IRS Tax Bracketsat December 2011
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2011 IRS Tax Example
Tax on a single taxpayers income of 40,000
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Calculate Taxes Owed

• The average tax rate the total tax due divided
  by taxable income
• Average tax rate lt marginal tax rate
• Example
• Taxable income 40,000
• Total tax bill 6,125
• Average tax rate 15.31
• or (6,125 / 40,000)

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Calculate Taxes Owed

• Alternative minimum tax (AMT)
• Paid by taxpayers with high amounts of certain
  deductions and various types of income
• Designed to ensure that those who receive tax
  breaks also pay their fair share of taxes

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Calculate Taxes Owed

• Tax credits
• Amount subtracted directly from the amount of
  taxes owed
• Examples
• Earned income credits
• Foreign tax credits
• Child and dependent care credits
• Retirement tax credits
• Adoption tax credits
• Hope Scholarship and Lifetime Learning credits

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Tax Credit versus Tax Deduction

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Determining Your Tax Liability
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Making Tax Payments

• Payroll Withholding
• Based on the number of exemptions and the
  expected deductions claimed
• Estimated Quarterly Payments
• Estimated tax payments made throughout the year
  based on income made during the year and reported
  on various Forms 1099.

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Watching DeadlinesAvoiding Penalties

• Form 4868 ? automatic six-month extension
• Submit estimated tax due with Form 4868 by April
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• Penalties Interest
• Underpayment of quarterly estimated taxes may
  require paying interest on the amount owed
• Underpayment due to negligence can result in
  penalties of 50 to 75 percent

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Prepare a Federal Income Tax Return

Every citizen or resident of U.S. and every U.S.
citizen who is a resident of Puerto Rico is
required to file income tax.

• Five filing status categories
• Single or legally separated
• Married, filing jointly
• Married, filing separately
• Head of household
• Unmarried individual or surviving spouse who with
  a child or dependent relative
• Qualifying widow or widower (Year of the spouses
  death plus two additional years)

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Which Tax Form Should You Use?

• 400 federal tax forms and schedules
• Basically the choice is between 3 forms
• 1040EZ
• 1040A
• 1040
• Which form to use?
• Type of income
• Amount of income
• Number of deductions
• Complexity of tax situation

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Completing the Federal Income Tax Return

• Filing status and exemptions
• Income
• Adjustments to income
• Tax computation
• Tax credits
• Other taxes (such as from self-employment)
• Payments (total withholding and other payments)
• Refund or amount you owe
• Refunds can be directly deposited to your bank
  account.
• Payments may be directly debited from your bank
  account.
• Your signature Most common filing error

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Mississippi State Income Tax

• All but 7 states have a state income tax
• Mississippi (2010)
• 1st 5,000 or part of taxable income is
  taxed at 3
• Next 5,000 or part of taxable income is
  taxed at 4
• Remaining Balance of taxable income is taxed
  at 5
• States usually require income tax returns to be
  filed when the federal income tax return is due

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How Do I File My Taxes Online?

• Tax preparation software
• TurboTax and H R Block At Home are two of the
  most popular tax preparation software packages
• Using software can save 10 or more hours
• Tax software allows you to complete needed tax
  forms
• Print and mail the forms or file online
• e-filing refunds usually take 3 weeks
• Cost for e-filing 5 - 40

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How Do I File My Taxes Online?

• Free File Alliance
• Online tax preparation and filing free to many
  taxpayers
• http//www.irs.gov - go to Free File
• Various qualification criteria to file free use
  Guide Me to a Service
• Connect to selected firms website
• Use forms online software to prepare and file
  tax return

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Available Tax Assistance Sources

• IRS Services
• Publications and forms
• 1-800-TAX-FORM
• www.irs.gov
• Recorded messages
• 1-800-829-4477
• Phone hot line
• 1-800-829-1040
• Walk-in service at an IRS office

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Available Tax Assistance Sources

• Tax publications
• e.g. Ernst and Young Tax Guide and J.K. Lassers
  Your Income Tax
• The Internet
• Tax preparation software companies
• Tax Preparation Services
• Tax preparers charge between 40 and 2,000
  depending on the complexity of the return
• Over 40 million U.S. taxpayers pay someone else
  to do their taxes

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Types of Tax Preparation Services

• One-person, local offices to large firms such as
  H R Block
• Enrolled agents Government-approved tax
  preparers
• CPAs
• Attorneys

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Evaluating Tax Services

• Factors to consider
• Training and experience of the tax professional?
• Fee for preparing taxes and how determined?
• Questionable deductions suggested?
• If return is audited will the preparer represent
  the client?
• Is tax preparation the main business activity or
  is it a front for other financial (or
  non-financial) products? (I have seen signs
  advertising tax services at barber shops and
  mens wear stores.)

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Tax Service Warnings

• Ultimately you are responsible for providing
  complete and accurate information
• If your professional tax preparer makes a
  mistake, you are still responsible for paying the
  correct amount, plus any interest and penalties.
  A good preparer will reimburse any penalties and
  interest you pay. (I paid one in 2010!)
• Hiring a tax preparer does not guarantee that you
  will pay the correct amount
• Beware of tax preparers that offer refunds in
  advance
• Refund anticipation loans can charge interest
  rates in excess of 300

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What Tax Records to Keep

• Current tax forms and instruction booklets
• Social security numbers
• Copy of previous years returns
• W-2 forms from employers
• 1099 forms (interest, self employment)
• 1098 (mortgage interest paid)
• Receipts and documentation for expenses
• Investment business expense documents

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What if Your Return is Audited?

• 0.6 of all returns are audited
• If you claim large or unusual deductions you are
  more likely to be audited.
• Three types of audits
• Correspondence audit for minor questions
• Office audit takes place at an IRS office
• Field audit is the most complex, with an IRS
  agent visiting you at your home, your business or
  your accountants office

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What if Your Return is Audited?

• Audit Rights
• Request time to prepare
• Clarification of items being questioned
• Right to appeal audit results
• When Audited
• Decide whether to bring you tax preparer,
  accountant or lawyer
• Be on time for youre appointment bring only
  relevant documents
• Present evidence in a logical, calm and confident
  manner maintain a positive attitude
• Make sure your information is consistent with tax
  law
• Keep your answers aimed at the auditors questions

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Objective 4Select Appropriate Tax Strategies

• Tax Planning Strategies
• Practice tax avoidance
• Legitimate methods to reduce your tax obligation
  to your fair share but no more
• Financial decisions related to purchasing,
  investing, and retirement planning are the most
  heavily affected by tax laws
• Tax Evasion
• Illegally not paying all the taxes you owe,
• by purposely not reporting all income

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Tax Planning StrategiesMinimizing Taxes
If you expect Then you should Because
The same or a lower tax rate next year Accelerate deductions into this year Greater benefit to higher rate
The same tax rate next year Delay income into next year Delay paying taxes
A higher tax rate next year Delay deductions Greater benefit
A higher tax rate next year Accelerate income Taxed at lower rate
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Tax-Planning Strategies Consumer Purchasing

• Home ownership
• One of the best tax shelters
• Deduct mortgage loan interest and
  property taxes
• Reduces your taxable income
• Use home equity line of credit to buy a car or
  consolidate debt
• Interest deductible
• Be careful the loan has to be
• paid back one of these days

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Tax-Planning StrategiesConsumer Purchasing

• Job-related expenses may be allowed as itemized
  deductions
• Union dues
• Business tools
• Job search costs
• Health care expenses
• FSAs (Flexible Spending Accounts) allow you to
  reduce your taxable income when paying for health
  related expenses

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Tax-Planning StrategiesInvestment Decisions

• Tax Exempt Investments
• Interest income from municipal bonds are exempt
  from federal and some state taxes
• Tax Deferred Investments
• Tax deferred annuities
• Section 529 education savings plans
• Retirement Plans -IRA, Keogh or 401(k)
• A type of tax shelter

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Tax-Planning Strategies Investment Decisions

• Capital Gains
• Profits from the sale of stocks, bonds or real
  estate
• Long-term capital gains (held more than one year)
  taxed at a lower rate
• Self Employment
• Advantage Owning your own business can have tax
  advantages
• Disadvantage Business owners have to pay
  additional taxes

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Tax-Planning Strategies Investment Decisions

• Childrens Investments
• Children with investment income of more than
  1500 are taxed at parents top rate
• Retirement Plans (These have different
  contribution limits depending on the situation.
  One should consult their financial advisor.)
• Traditional IRA
• Roth IRA
• Education IRA
• Keogh Plan
• 401 (K) Plan

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Changing Tax Strategies

• IRS Changes
• IRS modifies tax filing procedures each year
• Congress passes legislation to change the tax
  code each year.
• Take advantage of these changes for personal
  financial planning
• Personal Changes
• Consider changes in your personal situation and
  income
• Monitor your tax strategies to best serve your
  daily needs and long-term financial goals

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