Money Management

Federal Income Tax Chapter Seven

Notes

Our Tax System

o Taxes are collected from the citizens and businesses.

o The money collected is called revenue and is redistributed according to the needs and priorities set by Congress.

o The largest source of government revenue is income taxes, followed by Social Security and Medicare taxes.

What is a Progressive Tax?

o  A commonly accepted criterion of tax fairness is that individuals with different amounts of wealth or income should pay different amounts of taxes.

o  This theory is called the ability-to-pay principle.

o  Progressive Taxes are those that increase in proportion to income.

o  Under this system, the people with higher incomes not only pay more taxes but they pay them at a higher rate.

What is a Regressive Tax?

o  Regressive taxes are those that decrease in proportion to income. With a regressive tax, the person with the higher income pays a lower % of their income than those with a lower income.

o  Sales Tax is a perfect example of a regressive tax. Those who can least afford to pay the tax (the poor) are assessed the greatest amount in proportion to their income.

o  Sales taxes are often called “pay as you go taxes” because they are levied against your purchases.

o  Another example of a regressive tax is an excise tax. These are taxes on specific goods like cigarettes or alcoholic beverages.

o  Usually, lawmakers are criticized for these types of taxes saying they unfairly target the people who can afford it the least.

Proportional Taxes

o  Proportional taxes are those that stay constant even though the amount being taxed increases.

o  For example, property taxes are proportional .... All people owning property in a the same community pay the same tax rate for every $100 of assessed value.

o  Each year the property is assessed and the owner must pay the local tax assessor whatever is owed.

o  On a local level, these taxes often help pay for community services such as education, police and fire departments, and parks.

Components of the Tax System

o  Our tax system is complex. Both businesses and individuals pay income taxes and must file income tax returns each year.

o  The basic components that allow the tax system to operate efficiently are:

p The IRS p The country’s power to tax income p And each taxpayer’s willingness to pay his or her

fair share.

The IRS o  The Internal Revenue Service is an

administrative agency of the Department of the Treasury.

o  The main function of the IRS is to collect income taxes and enforce tax laws.

o  In local IRS offices, employees assist taxpayers in finding information and forms. They also print brochures and pamphlets to help taxpayers in preparing their returns.

IRS In the Community

The Power to Tax

o The power to levy tax rests with the Congress of the United States.

p  Must originate in the House of Representatives.

p  Must make it through votes in both the House and the Senate.

p  Must then be signed into law by the president

Paying your Fair Share

o  Our income tax is at a graduated rate, the more income you receive the more you pay.

o  Congress tries to balance its budget. p  If more money is spent than what is received there is a

deficit. p  If more comes in than is spent there is a surplus.

o  Currently the government is operating at large deficits. Tax cuts were put in place, decreasing revenue. However, spending has not decreased at the same rate.

o  Obviously, this is not a great example of money management! J

The Brand Spanking New 1040EZ form!

Filing a Tax Return o  Definition of Terms

ü  Filing Status – are you single, married filing as an individual, married couple filing jointly etc...?

ü  Exemptions – do you have dependents to claim on your return? §  You are entitled to claim yourself unless your parents still claim

you. §  In order to be claimed as a dependent a person needs to meet

FIVE requirements: §  Must be a relative (list of what qualifies is at the IRS website). §  Must be a citizen or resident of the U.S., Canada or Mexico, or an

adopted child who has lived with you all year. §  Must provide over half the persons support during the year. §  The person’s income must be less than the amount of his or her

exemption ($3,100 last year). This test doesn’t qualify for kids under 19 or kids who are college students (until 24).

§  If the person is married they can’t file a joint return with their spouse.

Filing a Tax Return (Continued)

§  Gross Income -- all the taxable interest you receive, including wages, tips, salaries, interest, alimony, worker’s compensation, and unemployment benefits.

§  Wages and Tips – Will be shown on your W2 form that is mailed to you by your employer.

§  Some adjustments are allowed to be subtracted from your gross income, like contributions to an IRA or a 401(k) retirement plan. Adjusted Gross Income is what is left after these adjustments are subtracted from gross income.

Legal Way to Lower your Tax Liability? J

Deductions

o Deductions are expenses that the law allows the taxpayer to subtract from adjusted gross income. n  All taxpayers are allowed to list certain expenses, which are

called itemized deductions. Things that might be deducted: p  some medical and dental expenses p  state and local property taxes p home mortgage interest p gifts to charity p qualifying job expenses .. To name a few.

n  If you don’t have enough of these types of deductions you can just chose the standard deduction.

Standard Deductions

o  Single -- $4,850 o  Married filing jointly or a qualifying widow(er) --

$9,700 o  Married filing separately -- $4,850 o  Head of household -- $7,150 o  If you're claimed as a dependent on someone

else's return -- $250 + earned income of at least $800 but not more than the standard deduction of $4850.

WHAT?

o  That might sound confusing but it’s actually not that bad

Gross Income - Adjustments = Adjusted Gross Income - Standardized Deductions - Exemptions = Taxable Income

o  Once you do this calculation, you’ve got your taxable income! Now you can see if you get a refund or not!

Who should file? When to file?

o Well just about everyone! ü  If you made enough to HAVE to file, then you better! ü  If you didn’t make enough to be required to file ... FILE

to RECLAIM the taxes that were taken out! If you don’t file you won’t get your refund!

o You must file no later than April 15th of the year after you earned the income!

o  If April 15th falls on a holiday or a weekend they give you until the next regular workday!

Is there an easy form?

Which form to use?

o  There are over 400 different IRS forms and schedules! WOW!

o  However, most people use one of three simple forms: n  Easiest – the 1040EZ –single, under 65, no more than one

personal exemption for yourself, not itemizing deductions, made less than $50,000. (About 17% use this form)

n  Next easiest – 1040A – single or married, can claim all the exemptions you are entitled to, not itemizing deductions, made less than $50,000. (About 19% use this form)

n  Next easiest – 1040 – single or married, all exemptions that you are entitled to, no limit to amount of money, want to itemize your deductions. (about 64% use this form)

Where to Begin?

o  Save all your important documents and receipts during the year. Throw them in a “Tax Folder”.

o  By January 31st you should receive your W2’s and any other forms needed to prepare your returns.

o  PREPARE EARLY! Might as well get that refund right away! J

o  Easiest way to complete the 1040EZ is by using tax preparation software and e-filing! Some still prefer to fill out the form themselves and mail it in! We’ll learn how to do it both ways in class tomorrow!