Calculations: Standard Deduction Method

1. Total income	$90,000
2. AGI	85,000	90,000-5,000 401k contrib
3. Minus standard deduction	-11,400
4. Minus exemptions	-21,900	$3,500*6
equals taxable income	51,700
5. Look up tax in tax table:
Tax:	1,675	10% on first $16,750
	5,385	15% on next amount
Calculate tentative tax	$6,918
6. Child tax credit	-3,000	(3 * $1,000)
7. Total tax due	$3,918

 

Calculations: Itemized Deduction Method

1. Total income (earned +interest)	$90,000
2. AGI	85,000	90,000-5,000 401k contrib
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 exemptions	21,900	(3,500* 6)
equals taxable income	45,775
5.  Look up tax in table	1,675	10% on first 16,750
	4,354	15% on next amount
Calculate tentative tax	$6,029
6. Child tax credit	-3,000	(1,000 * 3 kids under 18)
7. Total taxes due	$3,029

 

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

Their marginal tax rate, the tax rate they would pay on each new dollar of income is 15 percent 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 = 3,918/ 90,000 = 4.4%

Itemized deduction = 3,029/ 90,000 = 3.4%

 Recommendations

Method: 

Using the itemized versus the standard deduction nets a savings of $889 over the standard deduction. Matt and Janina should use the itemized method.

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 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, they could keep good records of these donations.

If they own a home, they could keep records of their home interest payments and property taxes.

2. Emphasize Capital Gains

If they have investments, they could use a passive strategy and purchase a low-turnover fund to minimize their mutual fund distributions, increase capital gains, and reduce their taxes.

3. Receive Tax-exempt Income

If his work has a flexible spending plan, they could contribute to this to pay medical bills with pre-tax dollars and reduce his AGI.

If they have investments, they could also invest in municipal bonds, which are federal tax-free (but would likely have a lower return).

4. Defer Income and Taxes to the Future

If they have qualified retirement plans at work, they could contribute to these plans (likely a  401(k) or 403(b) plan). These plans might also include a company match or free money. They must look to their budget and determine if they can  afford to do this. If they do not have qualified retirement plans, they both could contribute to a traditional Individual Retirement Plan to reduce their AGI.

They have kids, so I assume they want to provide for their education. They could contribute to education plans for their kids, i.e., an Education IRA or state 539 Plan, which would reduce their investment income in the future as interest on these vehicles is tax-free.

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