Updated September 25, 2006
1.†† Thomas Franklin arrived at the following tax information:
Gross salary, $41,780
Interest earnings, $225
Dividend income, $80
One personal exemption, $2,450
Itemized deductions, $3,890
Adjustments to income, $1,150
What amount would Thomas report as taxable income?
Thomas would have a taxable income of $34,595 resulting from $41,780 + $80 + $225 - $1,150 - $3,890 - $2,450.
2.†† If Lola Harper had the following itemized deductions, should she use Schedule A or the standard deduction? The standard deduction for her tax situation is $6,950.
Donations to church and other charities, $1,980
Medical and dental expenses that exceed 7.5 percent of adjusted gross income, $430
State income tax, $690
Job-related expenses that exceed 2 percent of adjusted gross income, $1,610
The standard deduction of $6,950 is better than itemizing deductions, which totaled $4,710.
3.†† What would be the average tax rate for a person who paid taxes of $4,864.14 on a taxable income of $39,870?
The average tax rate would be 12.2 percent.
Extra credit Ė what is the marginal tax rate and why is that important?
Answer: 25% (from tax bracket schedule). Marginal tax rate is important because that is the tax you pay on the last dollar. †Marginal tax is what affects your decisions (like the one in #7 below)
4.†† Based on the following data, would Ann and Carl Wilton receive a refund or owe additional taxes?
Adjusted gross income, $43,190
Itemized deductions, $11,420
Child care tax credit, $80
Federal income tax withheld, $6,784
Amount for personal exemptions, $7,950
Average tax rate on taxable income, 15%
Taxable income would be $23,820 ($43,190 - $11,420 - $7,950) times the average tax rate of 15 percent equals $3,573 less a tax credit of $80 gives a tax liability of $3,493. When compared to federal tax withheld ($6,784), the result is a refund of $3,291.
5.†† Which 1040 form should each of the following individuals use?
a.†† A high school student with an after-school job and interest earnings of $480 from savings accounts.
††††† The Form 1040A
b.†† A college student who, due to ownership of property, is able to itemize deductions rather than take the standard deduction.
††††† Form 1040
c.†† A young entry-level worker with no dependents and income only from salary.
††††† Form 1040EZ
6.†† Using the tax table in Exhibit 4-7, determine the amount of taxes for the following situations:
a.†† A head of household with taxable income of $26,210 ($3,424).
b.†† A single person with taxable income of $26,888 ($3,674).
c.†† A married person filing a separate return with taxable income of $26,272 ($3,564).
7.†† Would you prefer a fully taxable investment earning 10.7 percent or a tax-exempt investment earning 8.1 percent? Why?
Assuming a 28 percent tax rate, 10.7 percent times 0.72 equals 7.704 percent; an 8.1 percent tax-exempt return would be preferred.
8.†† On December 30, you decide to make a $1,000 charitable donation. If you are in a 28 percent tax bracket, how much would you save in taxes for the current year? If that tax savings was deposited in a savings account for the next five years at 8 percent, what would be the value of that account?
If you use excel (-$280 PV, rate 8%, 3 periods), $411.
1.†† What are Ericís major financial concerns in his current situation?
Ericís major financial concerns include providing for the current and future financial needs of his daughters, weak tax-planning activities, and limited use of investments with tax benefits.
2.†† In what ways might Eric be able to improve his tax-planning efforts?
Eric could take advantage of childcare tax benefits, change his withholding amount to avoid owing a large amount in April, and investigate tax-exempt or tax-deferred investments.
3.†† Is Eric typical of many people in our society with regard to tax planning? Why?
Yes, to some extent. Many believe the topic is too complex, but the content offered in this chapter is designed to provide a basic understanding of this vital area.
4.†† What additional actions might Eric investigate with regard to taxes and personal financial planning?
Other areas Eric might consider include the purchase of a home to take advantage of its tax benefits and expanded use of tax-deferred retirement plans.
5.†† Calculate the following:
a.†† What is Ericís taxable income? (Refer to Exhibit 4-1)
††††† Taxable income is $26,180
††††† ($42,590 + $125 + $65 - $2,000 - $8,250 - $6,350)
b.†† What is his total tax liability? (Use Exhibit 4-7) What is his average tax rate?
††††† Tax liability is $3,016 ($3,416 from tax table less $400 tax credit). His average tax rate is 11.52 percent ($3,016 divided by $26,180).
c.†† Based on his withholding, will Eric receive a refund or owe additional tax? What is the amount?
††††††††††† Eric receives a refund of $162. ($3,178 withheld less $3,016 liability.)