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Tax Planning

Objectives

• A. Understand what our leaders have said regarding taxes

• B. Understand the importance of tax planning and how it helps attain your personal goals

• C. Understand the tax process and strategies to help lower your taxes (legally and honestly)

• D. Understand the major tax features of our tax system

Your Personal Financial Plan

• Section V.: Taxes• What Tax Form and Tax Strategies did

you use last year?• What was your marginal and average

tax rates?

• Action Plan:• What Tax Form and Tax Strategies

should you use this year? • What else can and should you do to

reduce your tax bill to Uncle Sam?

A. Understand our Leaders Counsel on Taxes

• The Lord has said:• Let no man break the laws of the land, for he

that keepeth the laws of God hath no need to break the laws of the land. Wherefore, be subject to the powers that be, until he reigns whose right it is to reign, and subdues all enemies under his feet. (D&C 58:21-22)

• The 12th Article of Faith states: • We believe in being subject to kings,

presidents, rulers, and magistrates, in obeying, honoring, and sustaining the law.

Our Leaders Counsel (continued)

• Some have tried to minimize this obligation. President Harold B. Lee instructed:

• “There seem to be those among us who are as wolves among the flock, trying to lead some who are weak and unwary, . . . who are taking the law into their own hands by refusing to pay their income tax.” (Ensign, January 1973, p. 106.)

• In the April 1973 Priesthood Bulletin the Church reaffirmed its position stating:

• “We ask priesthood leaders to be on guard against such persons. . . Priesthood leaders should teach the necessity of abiding the law according to the revelations. (Priesthood bulletin, April 1973)

Questions

• Any questions about what our leaders have said about paying taxes?

B. Understand How Tax Planning can help attain your Personal Goals

• Why tax planning?• Taxes are your largest single annual expense• The average American works more than 4

months just to pay his or her taxes• In sum: the less you pay Uncle Sam, the more

you have for your personal and financial goals!

Tax Freedom Day

• Figure 1: Tax Freedom Day, 1980 – 2006• Source: Tax Foundation, Washington, D.C.,

http://taxfoundation.org/UserFiles/Image/Tax-Freedom-Day/2006.

The Impact of Taxes

Estate Planning

Investing

Budget

Savings and Debt

Retirement Planning

Insurance

Cash Management

Goals

Taxes

Questions

• Any questions on the impact of taxes and your personal goals?

C. Understand the Tax Process and Strategies to Reduce Taxes

1. Start with income from all

sources less exclusions =

Gross Income

2. Subtract adjustments to

Gross Income = Adjusted Gross Income (AGI)

3. Subtract the greater of

Standard or Itemized

Deductions

4. Minus exemptions = Taxable

Income

5. Look up tax on tax table = Tentative Tax

6. Minus credits = Total Tax

Owed

7. Minus taxes already paid = Balance Due or

Amount of Refund

Definitions

• 1. Total Income• Total income for tax purposes is all income from

whatever source, unless specifically excluded. It also includes some losses, such as net capital losses (up to $3,000), sole proprietorship losses, and active participation real estate losses.

• Specifically excluded includes certain employer provided fringe benefits, gifts and inheritances, beneficiaries of life insurance proceeds, scholarships or grants not in excess of college expenses, municipal bond income, interest for education savings vehicles used for education, and interest and earnings deferred on qualified retirement accounts

Definitions (continued)

• 2. Adjustments • Adjustments are deductions from total income

allowed by the IRS to get your Adjusted Gross Income (AGI). These include: amounts that defer retirement income (IRA, 401k, SEP IRA), and qualified medical savings contributions (flexible spending accounts), student loan interest and tuition and fees deduction (IRS 970) (within limits), one-half self employment tax, etc.


• 3. Standard Deductions• Deductions are IRS allowed reduction amounts

(standard deduction) or taxpayer determined amounts (itemized deductions) to get taxable income from your AGI.

• Year Standard Deduction (MFJ)

• 2003 $9,500• 2004 9,700• 2005 10,000• 2006 10,300• 2007 10,700


• 3. Itemized Deductions• Allowable deductions (if you itemize) include

charitable contributions (cash, in kind, and/or mileage), home mortgage interest, medical expenses (>7.5% AGI), un-reimbursed qualified job expenses (> 2% AGI), casualty and theft expenses (> 10% AGI), either state and local taxes or state and local general sales taxes, property taxes on principle residence, etc.


• 4. Exemptions• An exemption is an amount of money set by the

government that you can deduct for each qualifying person in your household. If you are married with 4 young children still at home, you have 6 exemptions

• Year Exemption Amount• 2003 $3,050• 2004 3,100• 2005 3,200• 2006 3,300• 2007 3,400


• 5. Tax Tables (married filing jointly [Schedule Y-1])Year If Taxable But not Tax Plus this Of the income is over over is percentage Excess

2005 0 14,600 0 10% 0 14,600 59,400 1,460 15% 14,600

59,400 119,950 8,180 25% 59,400

119,950 182,800 23,318 28% 119,950

2006 0 15,100 0 10% 0 15,100 61,300 1,510 15% 15,100

61,300 123,700 8,440 25% 61,300

123,700 188,450 24,040 28% 123,700

2007 0 $15,650 0 10% 0 $15,650 $63,700 $1,565 15% $15,650

$63,700 $128,500 $8,772 25% $67,300

$128,500 $195,850 $24,972 28% $128,500


• 6. Credits• Credits are dollar for dollar reductions in your taxable

liability. Credits are worth significantly more than deductions.

• Credits are either refundable (paid to the taxpayer even if the amount of the credits exceeds the tax liability) or non-refundable

• Refundable credits include reductions for earned income, taxes withheld on wages, estimated income tax payments

• Non-refundable credits include child tax, child and dependent care, elderly and disabled, adoption, hope learning, and lifetime learning.

Understand Tax Planning Strategies to Minimize Payments for a Given Level of Income

Four key strategies:1. Maximize Deductions

• Key Suggestions• Use your home as a tax shelter• Shift and bunch your deductions to get maximum

benefit in a specific year• Continue to give, with tithes and offerings,• Keep good records of all other charitable

contributions, including mileage and in-kind donations

Tax Planning Strategies (continued)

2. Maximize Long-term Capital Gains Income• Key Suggestions

• Long-term capital gains taxes are not paid until the asset is sold.

• Maintain a long-term buy and hold strategy on mutual funds and stocks and you pay no taxes until you sell.

• Long-term capital gains rates are taxed less than earned income (in some cases as much as 20% less - 35% versus 15%). Stay in for the long haul.

• Manage your portfolio in a tax-efficient basis.


3. Receive Tax-Exempt Income• Key Suggestions

• Look to tax-free investments. Municipal bond interest is federal-tax free, and may be state and local tax-free well

• Use Medical Savings Accounts (also called flexible spending accounts) to pay medical bills with before-tax dollars and to reduce income

• Donate to charities with appreciated assets. That way you do not pay taxes on the appreciated assets


4. Defer Taxes to the Future or Eliminate Taxes• Key Suggestions

• Invest as much as your budget will allow in your 401k/403b/457/Keogh and other tax-deferred retirement plans, especially if they are matched.

• IRAs, 401k defer taxes to the future so you do not have to pay taxes on this money until later

• Invest in education savings vehicles (i.e., 529 Plans and Education IRAs) which eliminate taxes on earnings if the assets are used for qualified educational expenses (exclusions)

Tax Recommendations for Soon to be Graduating Students

• 1. Be organized with your record keeping• Have a folder that you put all your tax receipts into

for tax time—keep it current• Use an electronic system such as Quicken or Money

to organize your finances. These programs make taxes easier if you use them

Tax Recommendations for Students (continued)

• 2. Keep prior year’s return• Use prior year’s returns as an example for the

current year• Make sure you take the same deductions each year

—or at least be aware of them• Keep prior year’s returns for 7 years


• 3. Go through checkbook and remember:• Keep good records so you can itemize deductions, • Get good at showing what non-cash charitable

contributions you make, such as miles you travel for church or scout related activities. These can be deducted at 14 cents per mile in 2006.

• Keep records of the non-cash donations you give to Deseret Industries, Salvation Army, etc. as these can be deducted if you itemize.


• 4. Spend time in December estimating capital gains, and offset them if possible with capital losses• Remember you can offset capital gains with capital

losses to manage your investment income• You can deduct up to $3,000 per year in capital

losses (every little bit helps)


• 5. Pay your tithes and offerings with appreciated long-term capital assets.• If you donate appreciated assets instead of selling

them, you do not have to pay the capital gains on those assets

• Donate the appreciated assets directly to the charities of your choice.

• For an example of paying tithing and other offerings with appreciated assets, see Teaching Tool 8: Tithing Share Transfer Example.

Questions

• Any questions on legal ways to reduce your tax bill?

C. Understand the Major Tax Features

• Four types of taxes:• 1. Income taxes• 2. Capital Gains taxes• 3. Income based taxes• 4. Non-income based taxes

1. Income Taxes

• Income taxes• Progressive tax meaning that the more you earn

the more you pay• Marginal tax rate

• Percentage of the last dollar that you earned that will go toward federal income taxes

• Average tax rate • Average amount of every dollar you earned that

was paid for federal income taxes• Effective marginal tax rate

• Average amount of every dollar you earned that paid for all local, state, and federal income taxes

2. Capital Gains Taxes

• Capital gains taxes • Can be postponed until you sell an asset for a

profit, but rates are dependent on how long the asset is held as well as the marginal tax bracket of the owner.

• While you can postpone capital gains taxes, you cannot postpone taxes on distributed earnings and dividends from mutual funds

• Short-term capital gains• Gains from assets held less than 12 months

• Long-term capital gains – taxed at 15%• Gains from assets held for 12 months or

longer

Capital Gains: What does Mean For You?

Investing:• Avoid frequent trading

• Buy for the long-term—don’t churn your portfolio• Buy low-turnover, “tax managed” mutual funds

• Index funds are very tax efficient• New laws make it a requirement to show tax

effects of mutual fund ownership• Buy individual stocks and make your own mutual

fund• You are not required to make annual distributions

as do mutual funds for individual portfolios

Capital Gains: What Does This Mean For You (continued)

Home Ownership:• Gains up to $500,000 for couples and $250,000 for

individuals from home ownership is exempt from taxes• Home must be your principal residence • Must have lived there 2 of the last 5 years• No need to “rollover gain” as before the Taxpayer

Relief Act of 1997

3. Income-based Key Taxes

• Social Security or FICA• A mandatory insurance program administered by

the federal government that provides support in the event of death, disability, health problems, or retirement.

• Tax rate of 6.20% of gross salary• Capped and adjusted annually for inflation over

which income is not taxed.• Medicare

• A health care insurance program for elderly and disabled.

• Tax rate of 1.45% of gross salary, with no annual cap.

Income-based Key Taxes (continued)

• Total FICA tax rate is 15.3% (12.4% Social Security + 2.9% Medicare).

• You are only responsible for half of the tax unless you’re self-employed. Then you must pay all 15.3%

• State and Local Income Taxes• Most states impose an income tax; however, some,

like Texas and Nevada, do not.• Local income taxes are uncommon; but some larger

cities, for example, New York City, impose such a tax.

4. Non-Income based Key Taxes

• Excise “sin taxes” and state sales taxes• Imposed when goods are purchased

• Real estate and property taxes • Imposed annually or semi-annually on

assets owned

• Gift and estate taxes • Imposed when assets are transferred from

one owner to another

Questions

• Any questions on the major tax features of our tax system?

Review of Objectives

• A. Do you understand what our leaders have said regarding taxes?

• B. Do you understand the importance of tax planning and how it helps attain your personal goals?

• C. Do you understand the tax process and strategies to help lower your taxes?

• D. Do you understand the major tax features of our tax system?

Case Study #1

Data: Matt and Janina, ages 42 and 40, are married and filling out their 2006 taxes. They have 4 children, 3 under 17 and one a dependent in college. They contributed $5,000 to a traditional IRA in 2006. They can only deduct medical bills above 7.5% of AGI, and job related expenses above 2% of your AGI. Exemptions are $3,300 per person, the standard deduction for married filing jointly is $10,300, and the child tax credit is $1,000 per child under 17.Tax rates for 2006 for married filing jointly are:• 0 to $15,100 10% • $15,100 to $61,300 $1,510 plus 15% of the amount over $15,100• $61,300 to $123,700 $8,440 plus 25% of the amount over

$61,300• Income: Earned Income $80,000• Interest Income 10,000• Expenses: Home mortgage interest 6,800• Un-reimbursed medical bills 7,000• Un-reimbursed Job-related expenditures 2,000• Tithes and offerings 9,600

• Calculations: Using the married filling jointly status and the information below, calculate their taxes first using the standard deduction and then using itemized deductions. Calculate their marginal tax rate and average tax rate on gross income.

• Recommendations: Which way should they calculate their taxes? What could they do to reduce their taxes?

Married with 4 children, 3 under 17; Tax rates: 0 to $15,100, 10%; $15,100 to $61,300, $1,510 plus 15% of the amount over $15,100; $61,300 to $123,700, 8,440 plus 25% of the amount over $61,300. Earned Income $80,000, Interest Income 10,000, Home mortgage interest $6,800, Un-reimbursed medical bills 7,000, Un-reimbursed job-related expenditures 2,000, Tithing 9,600. Can only deduct medical bills above 7.5% of AGI and job related expenses above 2% of AGI. Exemptions $3,300 per person, standard deduction $10,300, and child tax credit $1,000 per child under 17.

Married with 4 children, 3 under 17; Tax rates: 0 to $15,100, 10%; $15,100 to $61,300, $1,510 plus 15% of the amount over $15,100; $61,300 to $123,700, 8,440 plus 25% of the amount over $61,300. Earned Income $80,000, Interest

Income 10,000, Home mortgage interest $6,800, Un-reimbursed medical bills 7,000, Job-related expenditures 2,000, Tithing 9,600. Can only deduct medical bills above 7.5% of AGI and job related expenses above 2% of AGI. Exemptions $3,300 per person, standard deduction $10,300, and child tax credit $1,000 per child under 17.

Calculations: Standard Deduction Method• 1. Total Income $90,000• 2. less $5,000 401k contr. (AGI) $85,000• 3. Minus Standard Deduction -10,300 • 4. Minus Exemption -19,800 $3,300*6• Equals Taxable income 54,900 • 5. Look up tax in tax table:• Tax: 1,510 10% on first $15,100• 5,970 15% on next

$39,800• Calculate tentative tax $7,480 • 6. Child tax credit -3,000 (3 * $1,000)• 7. Total Tax Due $4,480

Married with 4 children, 3 under 17; Tax rates: 0 to $15,100, 10%; $15,100 to $61,300, $1,510 plus 15% of the amount over $15,100; $61,300 to $123,700, 8,440 plus 25% of the amount over $61,300. Earned Income $80,000, Interest Income 10,000, Home mortgage interest $6,800, Un-reimbursed medical bills 7,000, Job-related expenditures 2,000, Tithing 9,600. Can only deduct medical bills above 7.5% of AGI and job related expenses above 2% of AGI. Exemptions $3,300 per person, standard deduction $10,300, and child tax credit $1,000 per child under 17.

Calculations: Itemized Deduction Method• 1. Total Income (earned +interest) $90,000• 2. less $5,000 401k contribution (AGI) $85,000• 3. Deductions• Home Mortgage Interest 6,800• Medical Expenses 625 (7,000-(85,000*.075)• Job-related Expenditures 300 (2,000-(85,000*.02)• Tithing 9,600

• Total Deductions 17,325• 4. Minus Income Exemptions 19,800 (3,300*6)• Equals Taxable income 47,875• 5. Look up Tax in Table 1,510.00 10% on first 15,100• 4,916.25 15% on next

32,775• Calculated tentative tax $6,426.25 • 6. Child tax credit -3,000.00 (1,000 * 3 kids under 18)• 7. Total Taxes Due $3,426.25

Married with 4 children, 3 under 17; Tax rates: 0 to $15,100, 10%; $15,100 to $61,300, $1,510 plus 15% of the amount over $15,100; $61,300 to $123,700, 8,440 plus 25% of the amount over $61,300. Earned Income $75,000, Interest Income

10,000, Home mortgage interest $6,800, Un-reimbursed medical bills 7,000, Job-related expenditures 2,000, Tithing 9,600. Can only deduct medical bills above 7.5% of AGI and job related expenses above 2% of AGI. Exemptions $3,300 per

person, standard deduction $10,300, and child tax credit $1,000 per child under 17.

• Calculations: Calculate their marginal and average tax rate on gross income.

• Their marginal tax rate, the tax rate they would pay on each new dollar of income is 15% for both the standard and itemized deduction calculation

• Their average tax rate, the rate they actually pay in taxes is their taxes divided by their total income.

• Standard deduction = 4,480 / 90,000 = 5.0%• Itemized deduction = 3,426 / 90,000 = 3.8%

Case Study (continued)

• Recommendations• Method:

• Using the Itemized versus the standard deduction nets a savings of $1,054 over the standard deduction. Matt and Janina should use the itemized method as they have more money for their goals

• What could they do to reduce their taxes?• There are lots of different answers you could

give; however, you do not have specific data in the case that leads to any specific recommendation. Following are a few assumptions and ideas:


• 1. Maximize Deductions• If they own a home, they could keep records of

their home interest payments and property taxes which are deductible

• If they are involved in charity, they could deduct the miles they drive to and from the charity

• If they have non-cash contributions, such as donations to Deseret Industries or Goodwill, they could keep good records of these donations

• If they have appreciated financial assets, they could contribute these to charity instead of cash, reducing AGI and eliminating capital gains taxes


• 2. Emphasize Capital Gains and Stock Dividends• If they have investments, they could use a

passive strategy and purchase low-turnover mutual funds to minimize their mutual fund distributions (and taxes), increase long-term capital gains (which are taxed at a lower 15% or 5%, depending on your marginal tax rate, rather than your marginal tax rate)

• If they invest in stocks, stock dividends are taxed at a preferential rate of 15% versus bond interest at their marginal tax rate.


• 3. Receive tax-exempt income• It their work has a flexible spending plan

(FSP), they could contribute to their FSP to pay medical bills with pre-tax dollars and reduce their AGI

• If they have investments, they could invest in municipal bonds which are federal tax-free


• 4. Defer taxes to the future or eliminate future taxes• If they have qualified plans at work, they could contribute

a 401k, 403b or 457 plan. This might also have a match and it would reduce their AGI

• They both could contribute to a traditional or Roth IRA which would also reduce their AGI

• They have kids, they could contribute to 529 and Education IRA plans for their kids, which would reduce their investment income in the future

• If they wanted to save for retirement, they could use a a Roth IRA/401k/403b and never pay taxes on these earnings again

Case Study #2

Data• Your friend Brian, a financial analyst, comes to you

with this sure-fire method of reducing taxes. He says that if you buy into this product (this product can be many different types of tax-schemes), you will not have to pay taxes on the earnings and it will save you taxes as well. It doesn’t sound right, so Brian comes and asks:

Application• To what lengths should you go to avoid taxes? • Where should your best tax advice come from?

Case Study #2 Answer

• Any legal method. However, if it seems to good to be true, it probably is, so get another opinion. Its not worth losing your integrity or going to prison over bad tax advice.

• You are ultimately responsible for your choices and for paying taxes. Where you get your tax advice, and how and what you pay for your taxes and other obligations is your choice.

• Your best tax advice should come from those who make it a business of giving tax advice. In addition, the IRS has many publications which can help you as you determine the taxes you should pay.

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