Chapter 3
Dec 25, 2015
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).