Simple introduction to taxes

A way, way, way too simple

introduction to income, capital gains, estate,

gift, and generation

skipping taxes

Russell James, J.D., Ph.D., Dept. of Personal Financial Planning, Texas Tech University

We pay taxes on money we earn.

We pay taxes on money we earn. We call these income taxes.

We pay taxes when we sell something for more than we paid for it.

We pay taxes on money we earn. We call these income taxes.

We pay taxes when we sell something for more than we paid for it.We call these capital gains taxes.

The federal government charges these taxes

Most states do too

We (sometimes) pay taxes on money we leave to other people when we die.

We (sometimes) pay taxes on money we leave to other people when we die.We call these estate taxes.

To prevent tax free transfer of estates before death, we (sometimes) pay taxes on gifts to others.

We call these gift taxes.

The percentage we pay in taxes is not flat.

As incomeincreases the income tax percentage increases.

As incomeincreases the capital gain tax percentage increases.

As estate size increases the estate tax percentage increases.

As gift size increases the gift tax percentage increases.

2011 federal income tax brackets for a

single person

Marginal Tax Rate Taxable Income

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

How much taxes are owed on $5,000?

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

$5,000 x 10% = $500

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

($8,500 x 10%) + ($1,000 x 15%) $1,000

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

($850) + ($150) $1,000

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

($8,500 x 10%) + (($34,500-$8,500) x 15%) +(($40,000-$34,500) x 25%)$6,125

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

($8,500 x 10%) + ($26,000 x 15%) +($5,500 x 25%)$6,125

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

($850) + ($3,900) +($1,375)$6,125

A tax deduction

reduces taxable income

If I have $10,000 of taxable incomethen get a $1,000 deductionHow much taxable income do I have?

$10,000 - $1,000 = $9,000

If I have $100,000 of taxable incomethen get a $1,000 deductionHow much taxable income do I have?

$100,000 - $1,000 = $99,000

How much is a deduction

worth?

How much is a deduction worth?

The amount of the deduction X The marginal tax rate

Deduction value

How much is a $1,000 deduction worth to a person with $8,000 of taxable income?

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

$1,000 x 10% = $100

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

$1,000 x 28% = $280

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

$1,000 x 35% = $350

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

How much is a $1,000 deduction worth to a person with $9,000 of taxable income?($500 x 10%) +($500 x 15%)$125

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

How much is a $1,000 deduction worth to a person with $9,000 of taxable income living in Utah (with a 5% flat income tax)?

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

($500 x (10%+5%)) +($500 x (15%+5%))$175

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

($500 x 15%) +($500 x 20%)$175

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

($75) +($100)$175

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

$1,000 x 40% = $400

10% $0 – $8,50015% $8,501 – $34,50025% $34,501 – $83,60028% $83,601 – $174,40033% $174,401 – $379,15035% $379,151+

If I sell something for more than I paid for it, that profit is taxed as a capital gain

What I sold it for –What I paid for itCapital gain

What I sold it for – Basis = Capital gain

Instead of “What I paid for it”,

we use the term Basis

What I sold it for – Basis = Capital gain

Basis is

+ what I paid for it

+ any money I spent improving it

- any depreciation tax deductions I have already taken on it

If I owned the item for more than one year, it is a long-term capital gain

2013Ordinary

Income Tax Rate

Short-term Capital Gains

Long-term Capital Gains

Tax Rate Tax Rate15% 15% 10%28% 28% 20%31% 31% 20%36% 36% 20%

39.60% 39.60% 20%

We call these gift taxes.

There are no estate or gift taxes on up to $5,000,000 of transfers. The top rate is 35%.

For anyone dying after Dec. 31, 2012, there are no estate or gift taxes on up to $1,000,000 of transfers. The top rate is 55%.

Transfers to grandchildren with living parents, in excess of $5,000,000 total, may create generation skipping transfer taxes. This adds another 35% tax.

After Dec. 31, 2012, transfers to grandchildren with living parents, in excess of $1,000,000 total, may create generation skipping transfer taxes. This adds another 55% tax.

If, after Dec. 31, 2012, I earn an extra $100,000 to give to my grandchildren, how much will they get (if I live in California at all top marginal rates)?

Fed. Income Tax ($100,000 x 39.6%) = $39,600Cali. Income Tax ($100,000 x 10.3%) = $10,300Gift tax ($50,100 x 55%) = $27,550GST tax ($22,550 x 55%) = $12,402

$10,147

A way, way, way too simple

introduction to income, capital gains, estate,

gift, and generation

skipping taxes

Russell James, J.D., Ph.D., Dept. of Personal Financial Planning, Texas Tech University

Simple introduction to taxes

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