Understanding Income & Other Taxes: Withholdings, Payments, Non-Income Taxes - Prof. Diann, Exams of Economics

Download Understanding Income & Other Taxes: Withholdings, Payments, Non-Income Taxes - Prof. Diann and more Exams Economics in PDF only on Docsity! Chapter 4 Tax Planning and Strategies Importance of Tax Planning • In 1913, the 16th Amendment gave Congress the right to impose the first income tax • The average American works more than 4 months just to pay his/hers taxes Income Tax Structure • Progressive or Graduated Tax-- progressive tax meaning that the more you earn the more you pay • Tax Brackets -- income ranges for which the same marginal tax rate applies – 10%-35% • 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. Paying Your Income Taxes • Withholdings -- tax payment from each paycheck, determined on the basis of income and W-4 form • Quarterly estimated payments • Payments with the tax return (the dreaded April 15th) • Withholdings from stock, retirement funds, and prize or gambling winnings Social Security or Federal Insurance Contributions Act (FICA) • Social Security -- 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 4.20% of gross salary up to $106,800 in 2011…there is NO social security taken out after this maximum. Social Security or FICA (cont’d) • Medicare -- a health care insurance program for elderly and disabled • Tax rate of 1.45% of gross salary, with no annual cap. State and Local Income Taxes • Most states impose an income tax; however, some, like Texas, do not. • Local income taxes are uncommon; but some larger cities, for example, New York City, impose such a tax. Other Non-Income-Based Taxes That You Face • Excise “sin taxes” and State Sales Tax -- imposed when goods are purchased • Real Estate Property -- imposed annually or semi-annually on assets owned • Gift and Estate Tax -- imposed when assets are transferred from one owner to another 1) Who Has to File an Income Tax Return?  Single — $9,350  Head of Household — $12,000  Married Filing Jointly — $18,700  Married Filing Separately — $3,650  Qualifying Widower (with dependent child )— $15,050 Filing Status Classifications • Single • Married filing jointly • Married filing separately • Head of household • http://www.irs.gov/ 2) Sources of Taxable (Gross) Income • Wages, salaries, and tips • Capital gains, dividends, and interest • Alimony • Pension funds and IRA distributions • Business and farm income • Rental and royalty income • Social Security and unemployment benefits Sources of Tax-Exempt Income • Roth IRA earnings • State and local municipal bond interest • Gifts and inheritances • Child support payments 1 • Federal income tax refunds • Veterans’ and welfare benefits 3) Gross Income minus adjustments = adjusted gross income (AGI) – Alimony payments – Selected IRA and other retirement contributions – 50% for Social Security and Medicare (selfemployed only) – Student loan interest, with limitations 4) Subtracting Deductions from Adjusted Gross Income (AGI) • Two methods –Itemize deductions –Standardized deductions IRS Limits on Itemized Deductions • Medical and dental expenses – must exceed 7.5% of AGI • Home mortgage and investment interest payments • Gifts to charity -- Keep good records, but must have receipt if the gift is more than $250 OTHER GIFTING…. • You can gift another person $13,000 per year tax deductible!! You write it off your taxes and they don’t pay taxes. Standard Deductions • Single -- $5,700 (2010) • Married filing jointly -- $11,400 (2010) • Head of household -- $8,400 (2010) • Widow/widower -- $11,400 (2010) 5) Claiming Your Exemptions • Exemptions are meant to provide everyone with some untaxed income, provided you don’t earn too much. • Personal exemptions – (blind, over 65) • Dependency exemptions 6) Calculating Your Base Income Tax on Taxable Income • Tax tables in the booklet. • Tax rate schedules -- must be used if income exceeds $100,000. 7) Determining Your Credits • Child credit • Hope Scholarship credit (your first 2 yrs in college) • Lifetime Learning credit (each year after first 2) • Child and dependent care credit • Earned income credit (EIC) (Check this one out!) • http://www.irs.gov/pub/irs-pdf/i1040a.pdf 8) Determine final tax liability 1. Total sources of income 2. Adjustments off Gross income 3. Deductions off Adjusted Gross Income 1. Itemized or standard ($1 here is worth your tax bracket percentage: 15%, 28%, 35%) 4. Exemptions (elderly, blind) 5. Arrive at taxable income—figure tax owed 6. Deduct credits off tax amount ($1 credit =$1 off tax) 7. Final amount you owe IRS Choosing a Tax Form • 1040EZ – taxable income less than $50,000 – can’t itemize or claim dependents • 1040A – taxable income less than $50,000 – allows for more sources of income • 1040 “Long Form” – allows the use of schedules 2 The Cost Factor $$ - Monthly fees -- Minimum balance - Charge per check The Convenience Factor - Direct Deposit (branches, ATMs) -Use own bank’s ATM to avoid fees -- Safety deposit boxes -Wills, insurance forms, jewelry - Overdraft protection -can save $20 per check The Consideration Factor - Personal attention - Do you like ATMs or do you want a person to give your money to? - Financial advice - Re: loans, investments, mortgages Electronic Fund Transfers (EFTs) for those of you who hate dealing w/other people ☺ - Automated bill payment: payments taken right out of checking or savings accounts - Automated teller machines: convenient - Debit cards - Smart cards Automated Teller Machines - Fees -- $1.00 to $5.00 per transaction (typically at non-affiliated ATMs) -- Security: location of ATM - Liability -- limited to $50 if you notify the holding institution within 24 hours of theft or loss Debit Cards - AKA: The plastic check - Advantages: - Avoid carrying cash - Avoid carrying a big credit card balance Smart Cards - Money is stored electronically on the card - Have similar usage as debit cards - Limit owner liability if stolen because the card doesn’t access an account - Examples -- Kinkos, ISU card, some grocery stores Chapter 6 Using Credit Cards: The Role of Open Credit Definitions and Examples of Credit - Credit – receiving cash, goods, or services with an obligation to pay later. - Closed credit – credit that you can must repay in fixed payments Examples – car loans, mortgages - Open credit -- credit that you can use and repay at your pace so long as you pay the required minimum monthly payment. -Examples -- Credit cards or department store credit cards Factors That Determine Creditworthiness -Annual income -Length of time at current residence -Length of time at current job -Number of bank accounts -Number of credit cards -Credit history Getting a Credit Card: The Five Cs of Credit - Character -Capacity -Capital -Collateral -Conditions Character: sense of responsibility toward debt repayment -Proven debt repayment history 5 - Job stability -Home ownership/rental length -Low debt load Capacity: ability to repay debt -Current level of income and source of income -Current level of borrowing (how many lines of credit do you currently have) -Level of non-obligated income -Debt including mortgage should be less than 36% of your gross income (debt to income ratio) Capital: size of your financial holdings -Investment holdings -Savings -Checking -Income -Assets Collateral: -Assets or property secured to obtain credit -The creditor holds the title or deed to the assets until repaid - If you default the asset is sold to repay debt -Typically secured assets include: automobiles, home, boats Conditions: extraneous factors -Impact the current economic environment may have on your ability to repay debt -Unemployment rate -Discount rate -Inflation rate My own personal C:CAUTION! -Theft -Protect the card itself and your card # -Identity theft -Shoulder surfing -Dumpster diving -Know Your Credit Card Philosophy - Credit user -Low APR - Convenience user -Low annual fee -Long, interest-free grace period -Free benefits - Convenience and credit user -Balance interest rate and annual fee for the lowest total cost Costs associated with credit cards -The balance owed -Interest rate/finance charge -Cash advance costs -The annual fee -Additional or penalty fees Balanced owed = Revolving balance -Revolving credit: -If you carry a balance from month to month on your credit card then you have a revolving balance. -Compound interest is calculated on revolving balances Interest Rates determines finance charge -Annual percentage rate (APR) –interest rate paid over the life of the loan -Teaser rates – introductory rates used to attract new customers, some as low as 0.0% -Most credit cards compound interest on a monthly basis (APR/12) Balance Calculation Methods - Average daily balance, most common -Including new purchases -Excluding new purchases - Previous balance – balance on previous month’s billing not including payments - Adjusted balance – balance on previous billing minus payments 6 Buying Money: The Cash Advance -Interest begins immediately and may be at a higher rate than for purchases -Usually there is a “cash advance fee” of 2% to 4% of the amount advanced -Some cards require payment of the purchase balance before payment of the cash advance balance The Grace Period -Normally 20 to 25 days, excluding cash advances -Doesn’t apply if you carry a balance -Not all credit cards offer a grace period Fees -Range from $0 to $100 (American Express charges $300 for their Platinum card.) -Cash advance fee -Late fee (average $35) -Over-the-limit fee (average $35) Credit Evaluation: The Credit Bureau -Credit Bureau: collects and reports information from creditors, public court records, and the consumer. -Determining your creditworthiness – credit scoring determines if you qualify for credit and the interest rate offered. Information on Your Credit Report -Personal demographics - Age, Social Security number, address -Employment history -Credit repayment history -Criminal convictions and judgments -Previous two years of inquiries by creditors National Credit Reporting Bureaus -Equifax Credit Information Services -Experian -Trans Union Free Credit Report! -http://www.ftc.gov/bcp/conline/pubs/credit/freereports.htm Just Say No -When you have the credit card that you want and want mail offers to cease: -Call: 1.888.567.8688 - 1.888.5OPTOUT -Takes a couple of weeks and the mail solicitation will stop Chapter 7 Using Consumer Loans: The Role of Planned Borrowing Characteristics of Consumer loans • Single payment (balloon) vs. installment loans (annuity) • Secured vs. unsecured • Variable rate (tied to other national rate) vs. fixed rate The Loan Contract: all the conditions of the loan • The APR • The amount and number of payments • total amount financed • how interest is calculated The Loan Contract: The Clauses 1. Insurance agreement clause 2. Acceleration clause 3. Deficiency payments clause 4. Recourse clause 1) Insurance Agreement Clause • Requires you to purchase credit life insurance that will pay off your loan after your death • Normally benefits only the lender • Increases your total loan cost 7 - Is a tangible consumer durable: a good that provides benefits that extend beyond one year. Expenses - Expenses for auto include: - Insurance (vehicle model, driving record) - Licensing (annual periodic expense) -- Maintenance & operating expenses (SUVs drink more gas than a Hyundai) - Financing charges if applicable Smart Buying - Do your homework. - Is the purchase a “need’ or “want”? - R U just having a midlife crisis? - Does the purchase fit your budget? - Will you end up “car poor?” - Will you lease or buy? - Will you buy new or used? Leasing - Sign a lease - negotiate a fair vehicle value (also known as the: gross capitalized cost) -- Negotiate your trade in price (Kelly Blue book) - www.kbb.com - Negotiate a low finance charge - Choose a vehicle with slow depreciation Types of Leases - Closed-end leases, or walk-away leases - normally offer a purchase option - require the dealer to be responsible for resale -- account for about 80% of all leases - Open-end leases - compare the fair market value to the lease’s residual value of the vehicle - are to be avoided because you pay the difference When Is Leasing A Good Option? - If you are financially stable. - If you drive less than 15,000 miles annually. - If you take good care of your vehicles. - If you use your vehicles for business travel. - If you do not modify your vehicles. - If the vehicle you are considering doesn’t depreciate too quickly. Your Monthly Lease Payment - Your lease payment depends on the following factors - agreed-upon price -- up-front fees - down payment or trade allowance - residual value - finance charge - length of the lease Amount you pay for lease - No easy formula…. - www.leasesource.com/workshop - Lease payments are generally less than purchasing payments. - Many have large down payments Purchasing a vehicle - Narrow down your selection. - Comparison shop: price, product features, and quality. -- Be informed: check library and Web sources. - http://autos.yahoo.com New or used? - New car: - Great Warranties available now: - Hyundai: 10 year, 100,000 mile warranty 10 - Chrysler, Dodge, Jeep: 7 year, 70,000 mile - 0.0% financing for up to 72 months - Must meet credit qualifications - Rebates - To you or to the dealer? New vehicles: - Invoice price - Price manufacturer charges the dealer - Base price - Cost of car including standard equipment & factory warranty - Dealer sticker price - Dealer installed options, and dealer markup - Monroney sticker price on side window - Base price + manufactured installed options, fuel economy & transportation charge Invoice price! - Generally, the most important price to know when shopping for a new car - The dealer cost may be less than invoice due to: - Rebates, discounts, allowances, incentives - Gives you the leverage you need to pay the price you want for your new vehicle - www.google.com - www.buyingadvice.com New Auto Purchase - Take advantage of new car sales, but negotiate the price - know the dealer’s cost of the vehicle (from invoice) - understand the various dealer markups or holdbacks!! - be aware of any rebate(s) that may apply - www.nadaguides.com New Auto Purchase (cont’d) - Evaluate financing alternatives - determine the length of financing - shop around to find the best interest rate - choose a financing period and rate to give you an affordable monthly payment - www.bankrate.com - Or use PVA to figure payment 0.0% financing vs. rebates - *Read the fine print!! You don’t usually get both! - 0.0% financing may be tied to huge down payment - May be “on select models only” - Rebates generally go to the dealer & are usually included in the advertised price Used vehicles: - Who absorbs the initial depreciation in price? - Some come with limited warranties - Best buy is a vehicle 2 to 3 years old - www.kbb.com - www.consumerreports.com Cementing the deal - Making your purchase. - Negotiate the price. - Consumer reports (have this with you) - Negotiate your trade in value - Kelly Blue book (have this with you) - Evaluate financing alternatives. - Complete the purchase. Consumer Protection and Your Car - Warranties - “secret warranties” - “lemon laws,” A Warranty - Is a promise by a manufacturer or dealer that it will repair or replace defects in your car, or that your car will be of a certain quality, for a specified period of time. - Express warranty: specific promises about the quality of the automobile 11 - Implied warranty: the automobile will work as expected (goes into drive when expected and not reverse) Secret Warranty - Aka “warranty adjustment” - Under these programs, the manufacturer will do free repairs on vehicles with persistent problems, even after the warranty expires, in order to avoid a recall and bad press. - To get these…..complain LOUDLY and in writing!! Lemon Laws - Nearly all State Lemon Law Statutes are based on the Federal Magnuson-Moss Warranty Act -- A vehicle that continues to have a defect that substantially impairs its use, value, or safety. Generally, if the car has been repaired 4 or more times for the same Defect within the Warranty Period and the Defect has not been fixed, the car qualifies as a Lemon. Georgia Lemon Laws - 1 repair attempt in the braking or steering system or 3 repair attempts or 30 calendar days out of service for other problems - 1 year or 12,000 miles. Calculating Car loan payments - LOAN AMOUNT = PVA - NUMBER OF PAYMENTS = N - INTEREST RATE = I/Y - CPT PMT = MONTLY PAYMENT. - **Conversions need to be made between APR and Monthly Percentage rate - **Conversions between Number of years and number of months.. - Abby is buying a new car for $34,000. She is financing this loan for 5 years at an Annual Percentage rate of 6.7%. What are Abby’s monthly car payments? - PVA = 34,000 - I/Y = 6.7/12 OR .5583 - N = 5 * 12 OR 60 - CPT PMT = $668.44 - Abby is buying a new car for $14,000. She is financing this loan for 3 years at an Annual Percentage rate of 5.7%. What are Abby’s monthly car payments? - PVA = 14,000 - I/Y = 5.7/12 OR .4750 - N = 3 * 12 OR 36 - CPT PMT = $424.01 Weighing the alternatives of renting vs. buying ¤ Personal and lifestyle considerations ¤ Financial considerations – http://www.kiplinger.com/tools/ Houses • Typically single-family, free-standing dwellings • Advantages – more space – greater privacy – builds equity • Disadvantages – maintenance time and costs – repair costs – resale hassles Coorpratives • Corporate-owned multi-unit dwellings in which the residents, as shareholders, own stock representative of the value of their unit. Monthly homeowner’s fee Condominiums • Multi-unit dwellings; residents have sole ownership of the living space but joint ownership of the land and common areas. Monthly maintenance fee Planned Unit Developments (PUDs) • Own home and land it sits on as well as shared ownership of the development. • Monthly homeowner’s fee for maintenance and common expenses. Popular on West Coast. From Sea to Shining Sea Where do you want to live? (compare school systems, proximity to shopping, safety) ¤ http://www.moving.com/Find_a_Place/Compare2Cities/ 12