After some serious look for income and expense, the next step is to look at the tax consequences and learn something. As a matter of fact, I have a system to track my tax liability related to income and tax-related activities throughout the year: when my portfolio depreciates, my tax liability will decrease; when a new batch of stock option gets vested, I add to my tax liability account to cover future tax consequences. Such a system gives me an advantage to understand my tax status and act toward favorable tax results.

For annual financial plan purposes, once I figured out income and expenses, the tax part is relatively easy. Below is my pro forma tax return for 2004 and 2005:

Again, for minimal confidentiality and adherence to employer policy, I didn't disclose my family's job income, but the above table showcases the framework for a year-start tax projection. A few notes when you read the table:

1) Adjusted Gross Income is way difference from my total income. The difference includes 401(k) contribution, flexible spending account contribution, vested stock options I don't plan to sell in 2005, my house's appreciation in accounting book, and certain non taxable income (like credit card rewards).

2) For both years, I will use itemized deduction. My deduction items include mortgage interest, property tax, state sales tax and some charitable contributions. My 2005 itemized deduction will be lower due to two factors: first, my mortgage interest payout will be lower in 2005 payout after a successful refinancing in 2004; second, my 2004 deduction includes the one-time item related to a car purchase.

3) I also factored in some regular year-over-year increase based on a CCH study in exemption amount and lower/upper limits in each tax bracket -- the impact is minimal.

4) In 2004, my federal income tax bracket is 25%. It will become 28% in 2005.

5) Child tax credit has a phase out schedule between $110,000 and $130,000 for married couple filing jointly. My 2004 status reflects partial credit for $1,000 per child and my 2005 income will exclude me from this benefit. (In fact, this phase-out schedule pushed my effective tax bracket to 30% in 2004.)

6) I don't have a dependent care credit because I became smarter to use flexible spending account to pay for daycare expenses.

7) So, if everything runs as planned, my 2005 federal tax due will be $24,613, a whole 49% increase over last year (while my top line will only grow 27%).

8) For a full tax analysis, I will also include the increase in my future tax liability due to floating capital gains/losses and newly vested stock options. This adds another $2,368 in 2004 and maybe $3,045 in 2005. These amounts will not be paid out for that particular year's tax returns, but I will keep them in my accounting book as future tax liabilities.

All in all, my % of income used to pay income tax will grow from 12% in 2004 to 14% in 2005. If I add the FICA tax, it will become 17% and 20%, respectively.

One important number to study from this tax analysis is the AGI. My projected AGI of $148,028 brings me very close to $150,000, which is the starting point of Roth IRA contribution limit phase-out. To bring my AGI down, I already subscribe to a big FSA contribution and max out 401(k) -- this means I need to plan my capital gains/losses more carefully to avoid triggering this phase-out schedule. (For more phaseout schedules, check out this CCH cheat sheet.)

So we have all pieces of the puzzle for a summary of the financial plan now! Read on.

(This post is part of the five-post Financial Plan 2005 series. If you miss some parts of the series, you might find links to all posts at Financial Plan 2005: The Overview.)