Transcript Understanding Income Taxes: Federal, State, and Local

Understanding Income Taxes:
Federal, State, and Local
Objectives
• Determine correct filing status
• Differentiate between standard and itemized
deduction
• Define personal exemption amount
• Define Adjusted Gross Income, Taxable
Income, Deductions and Credits.
Purpose of Income Taxation
Local, State and Federal governments collect
income taxes to help pay for various benefits
and services to citizens – including yourself.
– Deducted from wages
– Estimated payments
Paying taxes is the price we pay for living in a
civilized society.
Oliver Wendell Holmes, Jr.
Income Tax Rates
• Local – 1 to 1.5% or earned income
determined by your municipality
• Pennsylvania State – 3.07% most sources of
income
• Federal – all income from whatever sources
derived less deductions, adjustments and
credits. Graduated system (different tax rates
apply to different ranges of income) 0%, 10%,
15%, 25%, 28%, 33%, 35%
5 Steps to calculating Federal Income
Taxes
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Determine Gross Income
Calculate AGI (Adjusted Gross Income)
Calculate Taxable Income
Determine Tax liability
Subtract tax credits and pre-payments to
determine tax refund or balance due
1. Gross Income
• IRS definition: “All income from whatever
source derived”
– Wages, tips, bonuses
– Interest, dividends, capital gains
– Rent
– Lease
– Royalties
2. Determine AGI Adjusted Gross
Income
Even if you don’t itemize you can still benefit
from certain deductions e.g. :
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Educator expenses
IRA contributions
Tuition and Fees
Alimony
Student Loan Interest
Business loss
3. Calculate Taxable Income
• Subtract from AGI the larger of the Standard
Deduction or Itemized Deduction for your
filing status
• You can itemize: mortgage interest, real estate
taxes, income taxes paid, unreimbursed
medical and dental expenses that exceed 7.5%
of your AGI, work related expenses, charitable
contributions, etc.
3. Calculate Taxable Income cont’d
2008 Standard Deduction
Filing Status
Deduction Amount
Single
$5,450
Married Filing Jointly,
Qualified Widow(er)
Head of Household
$10,900
Married Filing Separately
$5,450
$8,000
Higher Standard Deduction Add’l $1,050 each taxpayer
Age > 65
and spouse
3. Calculate Taxable Income cont’d
Finally, subtract exemptions for household
members at $3,500
• Example: Family of 4 MFJ using standard
deduction with gross income of $80,000
$80,000
-$10,900 Standard Deduction
-$14,000 Exemptions
$55,100 Taxable Income
3. Calculate Taxable Income cont’d
• Example: Single person using standard
deduction with gross income of $80,000
$80,000
-$5,450 Standard Deduction
-$3,500 Exemptions
$71,050 Taxable Income
4. Calculate Gross Tax Using Tax Tables
10%
15%
25%
$8,025$32,550
$32,551$78,850
$78,851$164,550
Married Filing $16,050Jointly –
$65,100
Qualifying
Widow(er)
$65,101$131,450
$131,451$200,300
Head of
Household
$43,610112,650
$112,651$182,400
$32,551$78,850
$78,851$164,550
Single
$11,450$43,650
Married Filing $8,025Separate
$32,550
5. Subtract
• Tax prepayments
– Paycheck withholding
– Estimated tax payments
• Tax credits
– Earned Income Tax Credit
– Additional Child Tax Credit
– Other credits
Impact of Income on Taxation of
Social Security Benefits
• Total all sources of income:
– 50% of Social Security
– Taxable income
– Tax-Exempt income
• Compare to Base Amount of filing status
– S, MFS, HOH $25,000-$34,000 50% is taxed >
$34,000 – 85% of SS benefits taxable
– MFJ $32,000-$44,000 50% is taxed > $44,000- 85%
of SS benefits taxable
End Result
• Positive number = tax refund
• Negative number = tax balance due
• Penalties and interest may be charged for
significant underpayment
Tax Avoidance vs. Tax Evasion
• Avoidance – using tax code to legally pay the
least amount of taxes owed.
– Ex. Traditional IRA or 401(k) contributions.
• Evasion – illegal underpayment of taxes due –
willfully and deliberately not paying taxes
owed the government.
Tax Avoidance Tools
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Retirement Plans
U.S. Savings Bonds
Municipal Bonds
Charitable Contributions
529 College Savings Plans
Using Retirement Plans to shelter
income from taxes
• Employer Tax-Deferred Savings Plan
(401(k)s, 403(b)s, etc.
• Individual Retirement Account (IRA) if you
qualify contributions are considered an
adjustment to income (reducing your taxable
income)
• Age limits
• Income limits
U.S. Savings Bonds
• Promissory notes issued by the federal
government. $20,000 limit per person/year.
• Income earned is exempt from state and local
taxes
– State doesn’t tax income from federal debt
– Federal government doesn’t tax income from state
debt
• Earnings are federally tax-deferred for life of
bond – up to 30 years
• EE bonds and I bonds (inflation adjusted)
Municipal Bonds
• Municipal bonds -= long term debt issued by
local government and agencies
– Proceeds finance public projects such as schools,
parks, roads, bridges
– Purchased individually or in mutual funds
– Interest received is free from state and federal tax
if issued by Pennsylvania governments
Charitable Contributions
• Benefits charity and donor
• Consult advisors – legal, financial and tax prior
to taking action
Charitable Contributions cont’d
• Tax deductibility:
– IRS definition “qualifying charity”
– Certain limitations apply
– Type of donation
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Outright gift
Charitable lead trust
Charitable remainder trust
Charitable gift annuity
– Understand the benefits and consequences of
each type of donation before making a decision.
529 College Savings Plans
• Contributions PA state tax deductible up to
$______
• Earnings grow federal and state income tax
deferred
• Tax-free if proceeds used to fund qualified
education expenses
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