If they don't want to take the standard deduction, they can choose to make their own.
Taxpayers with itemized deductions in excess of the standard deduction will prefer to not do so.
This group includes people who own a mortgaged primary and/or second home.
The itemized deductions of the Meyers exceeded the standard deduction.
There is a tax advantage to owning a principal residence because interest on the associated mortgage loans is tax deductible.
Consumer interest paid on credit card accounts is not deductible, whereas investment interest paid on funds borrowed for personal investment purposes is.
The cost of allowable interest charges is reduced by tax deductibility.
Specific rules determine who is a dependent.
He claimed three exemptions.
If the taxpayer's income level is high enough, the personal exemptions may be phased out entirely.
In addition, certain unreimbursed employee expenses, such as investment management or 50% of entertainment bills, 100% of travel expenses, and 50% of meal financial planning fees, are deductible if substantiated by receipts.
Table 17.1 is used to calculate the tax due for the Meyers.
The tax on their investment income puts them in the 15% tax brackets.
Their tax is $4,785, which is the travel costs to look after.
When evaluating an investment strategy, the marginal tax rate of your attorney, accountant, or investment counsel should be considered.
The marginal tax rate should not be confused with the average rate.
A recent study found that taxpayers in the 15%, 25%, 28%, 33%, 35%, and 39.6% tax brackets will have a higher marginal than average corporate CFOs.
The average tax rate is irrelevant to the investment decision making of the Meyers'.
This error cost firms up to $25 million when making big attractive because they reduce taxes on a dollar-for-dollar basis, in contrast to decisions such as acquiring a deduction, which reduces taxes only by an amount determined by the mar another firm.
There are two frequently used tax credits, the credit for child and the adoption tax credit.
Some states give tax credits to parents who help their child save for college.
They were not eligible for tax credits.
The final amount of tax due is determined by subtracting tax credits from income tax.
The tax due is $4,785.
They have reduced this amount to the total of tax withholding and estimated taxes they paid last year.
If the total is less than $4,785, they must pay the difference when they file their federal income tax return.
The purpose of this law is to make sure that everyone pays their fair share of taxes.
Depending on the taxpayer's income level, the rate is either 26% or 28%.
The base is determined by making adjustments to the individual's regular income.
The procedures for determining the tax base are complex.
If you think the alternative minimum tax might apply, you should talk to a tax expert.
A comprehensive tax strategy tries to maximize the total after-tax income of an investor over his or her lifetime.
The goal is either to avoid taxable income altogether or to defer it to another period when it may receive more favorable tax treatment.
When deferral does not reduce one's taxes, it still gives the investor the use of saved tax dollars during the deferral period.
The most popular form of tax avoidance is investing in securities that offer tax-favored income, which is explained in greater detail in the next section.
A broad approach to avoiding taxes is to distribute income- producing assets to family members who either pay no taxes at all or pay them at much lower rates.
This is a highly specialized area of the tax law, so we don't pursue it further in this text.
Again, you should seek professional counsel whenever you have a tax strategy like this.
When it is known that tax rates will be lower, taxes are deferred for only one year as part of a year-end tax strategy to shift income from one year to the next.
The tax deferral is part of a long-term tax deferral strategy.
A simple way to defer taxes is to use vehicles that are specifically designed for this purpose.
In this chapter, the role of each vehicle is described.
You must own the asset directly.
If the Meyers had incurred a tax deductible loss on their investment property, it could have provided a tax shelter.
The net loss of $1,000 would have been the corporation's, if they had set up a corpora tion to own this property.
They could not have claimed the tax deductions on their tax return.
Huge losses show no immediate tax benefit to the shareholders of publicly owned corporations.
Although the market price of the stock probably falls, which means you could sell the stock at a tax loss, such a capital loss is limited to $3,000 a year.
If you owned a large amount of stock, your loss could be many times that amount and still not be used to reduce your taxes.
There is a tax advantage to organizing certain activities as sole proprietors or partnerships.
Losses from certain deductions can be passed on to individual owners.
The amount of losses that can be deducted when calculating income is limited by law.
The structure of the limited partnerships that are commonly used to organize tax shelters are explained later in the chapter.
Let's look at the investments that offer tax-favored income.
There is a return that is taxed at a lower rate than other investments.
These tax "favors" have been written into the tax law to encourage certain activities as well as to provide convenient tax reporting procedures.
Real estate can provide shelter from taxes for certain investors.
Deferred annuities and single-premium life insurance will be looked at later in the chapter, as well as a number of other tax-sheltered vehi cles and strategies.
Some items are not subject to taxation.
These include interest earned on tax-free municipals and on Treasury and government agency issues, as well as certain proceeds from the sale of a personal residence.
Investments in assets that enjoy special tax treatment are encouraged by tax exclusions.
Chapter 10 describes municipal bonds.
All interest received from the most common kind of municipal bond is free of federal income tax.
Capital gains or losses must be included in the sale of municipal bonds.
Interest on money borrowed to purchase bonds is not deductible.
Chapter 10 discussed the issues of treasury and government agency.
Interest on these securities is not included as income on the federal tax return for most issues.
States and localities are not allowed to tax interest income from federal government debt in order to make it easier and less expensive for the federal government to borrow.
State and local income tax rates can be as high as 20%, so individuals in high tax brackets may find these exclusions worthwhile.
If you sell your personal residence for more than the original price, you can make a capital gain.
A tax provision aimed at stimulating home ownership makes investing in a home an excellent tax shelter.
The exclusion applies to as much as $500,000 on a joint return.
The exclusion can be used as frequently as every two years under certain conditions.
A capital loss occurs if a personal residence is sold for less than its basis.
Capital losses for personal use assets are not deductible for individual income tax purposes.
Within a relatively short period of time, an investor may enjoy sizable gains in a security's value.
If you bought 100 shares of XYZ common stock at $30 a share in January 2016 and invested at the end of the year, your investment would have increased in value by 50%, to around $45 per share.
If you believe the stock price has peaked, you can sell it and invest the money in other things.
Capital gains will be taxed at your ordinary income tax rate if you have held the position for less than a year.
If you are in the 25% tax brackets, you would have a tax liability of $375 on the short-term capital gain and an after-tax position of $4,125.
If you can defer the recognition of the capital gain on the stock position, you would qualify for a 15% tax rate on the capital gain because the stock was held for more than a year.
Buying a put hedge and selling a deep-in-the-money call option are two strategies that can be used to preserve a capital gain.
The put hedge can be used to lock in a capital gain and defer the taxes on the gain to the next tax year.
If the price of the stock falls, your losses on the shares are offset by the payoff on the put option.
If you paid $75 to purchase a 6-month put option with an exercise price of $45, you would have made a profit.
If the price of the stock fell to $40 a share, your $500 loss on the stock would be offset by a $500 payoff on the option.
The cost of the option is an insurance premium for insuring the gain on the stock.
The short-term capital gain was taxed at the 25% ordinary income tax rate.
If the stock price stays above $35.63 a share, then the put hedge strategy provides a superior after-tax position by effectively reducing the taxes paid.
If the stock price fell to $35, the after-tax position would be equal to $3,500.
A call is an option that gives the holder the right to buy the underlying security at a specified price over a period of time.
When XYZ was selling for $45 a share, call options on the company with a $40 strike price and 6-month maturity were traded for $600 per share.
The $4,300 final after-tax position is better than the put hedge, but it closes the opportunity to benefit from further stock price appreciation.
You are agreeing to deliver your shares at the option's contractual buy price when you sell the call option.
Your downside protection only applies to the amount received for the option, not the application capital gains tax rate on the stock position.
The maximum stock price drop your call option position can offset is $6.
If XYZ's price fell below $37.94, your after-tax position would fall below $4,125 you could have had at the end of 2015.
If the stock price fell to $35, the after-tax position would be equal to $3,500.
Deferring tax liabilities to the next year is a potentially rewarding activity requiring the analysis of a number of available techniques.
It is possible to simplify the choice by considering the future price behavior of the stock.
The table summarizes how each strategy performs.
We did not include commission costs in the analysis.
Although these costs can be high in absolute dollars, they are usually a minor part of the total dollars involved if the potential savings are as large as we have been considering.
If the tax savings are relatively small then the commission may besproportionately large.
You need to work out the figures for each situation.
The most important reason for investing is to accumulate funds for retirement.
A large part of the retirement income of many people comes from Social person's cognitive ability.
The programs may decline after a certain age.
A study found that individuals have a combination of employer and employee contributions.
There was contribute to a retirement program that provided tax shelter by deferring taxes no equivalent decline in the to retirement if the employee had an option to exam after age 60.
401(k) plans, Keogh plans, confidence of older investors to IRAs, and individual retirement arrangements are some of the programs.
401(k) plans are the focus of our discussion here, but similar plans are also available for employees of the public.
It's a recipe for financial trouble in old age if you have a 401(k) plan.
Typically, participants in 401(k) plans can choose from a money market fund, company stock, one or more equity funds, bond funds, or a guaranteed investment contract.
A firm's pension plan manager invests employees' 401(k) contributions in large GIC contracts.
You won't have to pay taxes on 401(k) funds until you start drawing down the account at retirement.
You will be in a lower tax brackets at that point.
Firms that offer 401(k) plans often match all or part of your contribution up to a set limit, which is a special attraction.
Roughly 85% of the companies that offer 401(k) plans have some type of matching contribution program.
The appeal of 401(k) plans can be enhanced by matching programs.
In 2015, an individual can put as much as $18,000 into a tax-deferred 401(k) and 403(b) plan.
The limits for employer-sponsored retirement plans are adjusted for inflation each year.
A special "catch-up" contribution allows people 50 years old or older to contribute an additional $6,000 per year.
The tax-deferred contributions are locked up until the employee is 59 1/2 years old.
If you earned $60,000 in 2015, you should contribute $16,500 to the 401(k) plan where you work in order to see how tax-deferred plans work.
You can lower your federal tax bill by $4,125 if you reduce your income to $43,500.
A good portion of your contribution will be offset by tax savings.
If you add $16,500 to your retirement program with only $12,355 of your own money, the IRS will take care of the rest.
All the earnings on the initial contribution and the investment earnings accumulated on them are deferred until retirement.
Like contributions to 401(k) plans, payments to Keogh accounts may be taken as deductions from taxable income to reduce the tax bill of self-employed individuals.
In 2015, the maximum contribution was $53,000 per year, or 25% of net earned income, whichever is less.
After the Keogh contribution, net earned income is the amount of earned income.
The actual contri bution is reduced to 20% of gross earned income.
A person who earns $220,000 can only contribute 25% of their income, which is $44,000.
Anyone who is self-employed, either full or part-time, is eligible to set up a Keogh account.
For example, the engineer who has a small consulting business on the side and the accountant who does not work full time can use the Keoghs.
For example, take the engineer.
If he earns $10,000 a year from his part-time consulting business, he can contribute 20% of his income to his Keogh account and use it to reduce his taxes.
He can receive full retirement benefits from his full-time job.
The accounts can be opened at many financial institutions.
You have until April 15, 2016 to make a contribution to your Keogh if you don't make it by the time the tax return is filed.
The funds in a Keogh account are held by a designated financial institution, but the actual investments in the account are held by the individual contributor.
These are self-directed retire ment programs, unlike the 401(k) plan.
Subject to a few restrictions, the individual decides which investments to buy and sell.
All growth and income is tax-deductible.
One downside for a small business owner is that they have to make contributions for eligible employees.
This increases the cost of the plan for the employer.
Unless the individual becomes seriously ill or disabled, the contributions must remain in the account.
You don't have to start withdrawing funds at age 59 1/2.
M18_SMAR3988_13_GE_C17.indd can stay in the account and continue to earn tax-free income until you turn 70 1/2, at which time you have the remainder of your life to liquidate the account.
As long as the self-employment income continues, an individual can continue to make tax deferred contributions to a Keogh account up to the maximum age of 70 1/2.
All withdrawals from a Keogh account are subject to the payment of ordinary income taxes once an individual starts withdrawing funds.
When they will have to be paid, the taxes on all contributions to and earnings from a Keogh account are deferred.
Those with no employees want a plan that is simple to set up and admin ister.
In place of Keoghs, SEPs can be used.
Employers are responsible for making contributions on behalf of their employees.
The creation of a new retirement plan for small business owners and individuals was authorized by Congress in 1996.
The cost of adopting a regular 401(k) plan and meeting annual "testing" requirements can be too much for a small business owner.
The Savings Incentive Match Plan for Employees (SIMPLE) IRA plan was designed to ease that burden while allowing significant contri butions on the part of employees.
Contributions to a SIMPLE IRA are tax-deferred.
The SIMPLE IRA is subject to the same rules as a traditional IRA.
Active participation for IRA deduction eligibility is defined as participation in a SIMPLE plan.
The employer has to make a contribution to the retirement plan.
The SIMPLE is a retirement savings plan for businesses with 100 or fewer employees.
Employees who have earned at least $5,000 in the previous two years are eligible to participate.
The SIMPLE plan is ideal for an individual who has a second business, since the contribution limit is 100% of income up to $12,500 in 2015.
The same as any other investment account you open with a bank, savings, credit union, broker, mutual fund, or insurance company, the ally was $59,000 loan, credit union, stockbroker, mutual fund, or insurance company.
To open the retirement plans, you must complete the form: An Analysis of the account designates the account as an IRA and makes the institution its Trustee.
For taxpayers more than 50 years old, the annual IRA contribution maximum was $6,500.
IRA contributions may be fully, partially, or nondeductible.
Employees are not covered by an employer-sponsored retirement plan.
Up to the lesser of the annual contribu tion limit or earned income, an IRA contribution is fully deductible.
If joint income is less than $181,000, a fully deductible IRA contribution can be made on behalf of a non-employed spouse.
If joint income is between $181,000 and $191,000 with no contribution allowed, a partially deductible IRA contribution is allowed.
An employer-sponsored retirement plan is covered by the employee.
If the employee's income does not exceed certain levels, the contribution is partially deductible.
If modified AGI exceeds the phase-out limits, an IRA contribution is nondeductible.
It's available to certain taxpayers.
We describe the characteristics of the other forms of IRAs before describing the benefits of deductible IRAs.
Contributions to other IRAs reduce the annual limit.
There is a phase-out of the limit for couples with adjusted gross income in excess of $183,000 and for singles with adjusted gross income in excess of $116,000.
You will have already paid taxes on the money you put into it if you make a contribution to a Roth IRA.
If your account is at least 5 years old and you are 59 1/2 years old, you can take out your money tax-free.
You may be subject to a 10% penalty if the earnings are taxed.
It's obvious that a tax-free IRA is an attractive vehicle for tax deferral.
Unlike the other types of IRAs, contributions to this IRA are not tax deductible, but withdrawals are taxed.
The contribution limits and penalties on nondeductible IRAs are the same as those on the traditional deductible IRA, except that there is no income cutoff.
The IRAs described so far allow the withdrawal of cash without the 10% early withdrawal tax penalty if the money is used to buy a first home or fund a college education.
All three IRAs allow penalty-free withdrawals for any reason starting at age 59 1/2.
You can leave your money in the account for as long as you want, unlike the traditional and non-deductible IRAs, which require withdrawal by age 70 1/2.
The other IRAs do not permit penalty-free withdrawal until age 59 1/2, while the Roth IRA allows withdrawal at any time without penalty or taxes.
You are free to make investment decisions with the capital in your IRA, as long as you are within limits.
Banks and thrift institutions push savings vehicles, insurance companies have annuities, and brokerage houses offer everything from mutual funds to stocks, bonds, and annuities.
Any withdrawals from an IRA prior to age 59 1/2 are subject to a 10% penalty on top of the regular tax on the withdrawal itself.
Deductible IRAs, along with all other retirement plans that allow contributions on a pretax basis, do not eliminate taxes.
Contributions and investment earnings are taxed when they are received in retirement.
The impact of tax deferral is substantial.
Table 17.4 compares the results of investments in a traditional deductible IRA and a non-IRA account, both of which earn an annual rate of return of 8%.
You should invest $1,000 of earned income each year.
If you choose the traditional deduct ible IRA, you shelter from taxes both the $1,000 initial investment and its subsequent earnings, so that at the end of the first year, you have accumulated $1,080.
If you choose the same investment vehicle but don't make it an IRA, you will have to pay $250 in taxes and invest $750.
After-tax income of $60 is also taxed at 25%, leaving it at only $45.
The first year'sAccumulation is just $795.
Contributions and earnings are taxed at 25% in the non-IRA account but are tax-deferred in the traditional deductible IRA; an annual rate of return of 8% is assumed in both cases.
After 45 years, the funds are 2.5 times as great as the non-IRA.
When earnings are not taxed, the power of compounding is even greater.
The $417,426 has not been taxed yet.
Tax-deferred investing has an advantage over taxable investing.
As with any investment, an individual can be conservative or aggressive when choosing securities for a Keogh or IRA, though the nature of these retirement programs generally favors a more conservative approach.
It is recommended that you fund your IRA with income- producing assets.
It is best to look for capital gains outside of your retirement account, according to this strategy.
Growth oriented securities are riskier and you can't write off losses from the sale of securities held in a Keogh or IRA account.
It is possible to place a good-quality growth stock or mutual fund in a Keogh or IRA.
The amount of money you have in your retirement account is more important than the amount of money you make.
Some investments should be avoided simply because they are not appropriate for such accounts.
With tax-free municipal securities, the tax shelter from a Keogh or IRA would be redundant because their income is tax-exempt.
Money market accounts, as well as bank deposits and mutual funds, appeal to Keogh and IRA investors because of their ability to capture volatile market interest rates.
As the size of an account increases, an investor uses more than one type of security to keep their portfolio diversified.
The underlying risks of the securities held in these accounts are not affected by the tax advantages of Keoghs and IRAs.
When money is put into a Keogh or IRA, it's meant to stay there for a long time.
There are a number of tax-deferred retirement accounts available to individuals.