My Personal Finance Journey

Personal finance observation, musing and decisions in a journey toward financial independence by 2020 with at least $3 million.

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Financial Plan 2005: Tax

Contributed by mm | February 5, 2005 11:03 PM PST

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:

 Income  2004 2005
   My Income     
   My Wife's Income     
   401(k) Contribution     
   Unrealized Stock Option     
   Flexible Spending Account     
   Total W-2 Income     
   Taxable Interest     
   Other Taxable Income     
   Capital Gain (Loss)     
 Adjusted Gross Income   $   120,705  $   148,028
   Deductions   $    (15,873)  $    (14,000)
   Exemptions   $      (9,300)  $      (9,450)
 Taxable Income   $     95,532  $   124,578
   Total Tax   $     17,358  $     24,613
   Child Tax Credit   $         (465)  $            -  
   Dependent Care Tax Credit   $         (412)  $            -  
 Total Income Tax   $     16,481  $     24,613
   Increase of Future Tax Liability   $       2,368  $       3,045
 Total Income Tax Burden   $     18,850  $     27,659
Total Income  $   154,498  $   196,385
Income Tax as % of Income 12.2% 14.1%

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.)

This Post Has Received 52 Comments. Share Your Opinions Too.

KB Commented on February 7, 2005

Note #2:
One of the item your are deducting in 2004 is related to car purchase. I'm curious to know are you doing this as a business expense? what exactly are you deducting - sale taxes or car price?
BTW great blog for Personal Finance.

mm Commented on February 7, 2005

Good question KB! It is the sales tax associated with the car purchase. Check this out:

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