Name: ___________________________________ Date: ________

Financial Literacy Notes

Income and Taxes

Objectives:

• Identify different types of income and employee benefits.• Relate taxation to government spending.• List goods and services government provides.• Identify different types of taxes.• Identify common tax forms.• Describe basic procedures for filing a tax return.

• Explain the purposes and function of the Social Security system.

The Many Forms of Income

• Income is money earned from employment and investments

• Governments tax income and assets to create revenue that is used to provide public goods and services

Earned Income

Income received from employment is ________________________.

Earned income includes:

– ________________________

– ________________________

– ________________________

– ________________________

– ________________________

– ________________________

Employee Benefits:

– Some of the most valuable forms of employee compensation are not monetary

– Employee benefits often include:

– ________________________, ________________________, ________________________

– ________________________

– _______________________________________________________

Business Profit Income

• Income earned by the self-employed

• Disadvantages of self-employment:

– Must arrange and pay for own employee benefits; can be costly

– Must pay entire Social Security and Medicare tax, rather than half the cost

Payroll Deductions

Net income (take-home pay) is gross income minus payroll deductions

• Deduction can lower a paycheck by 20 percent or more

• Bonuses increase gross income

• Common payroll deductions:

• FICA (Federal Insurance Contributions Act): Social Security and Medicare

• Federal withholding tax

• State and city withholding taxes, if applicable

• Other benefits (insurance purchased through employers)

Money Earned Outside of Work

• Unearned income—income received from sources other than employment – earnings from investments, sale of assets, and interest paid on savings and bonds– Social Security and retirement account payments– rent, inheritance, awards, gifts, alimony– unemployment compensation

The Importance of Taxes

• Government uses its taxing authority to

– ______________________________________________________

– ______________________________________________________

– ______________________________________________________

– ______________________________________________________

Federal Government Spending

• Limited resources force governments to make choices

• A budget reflects priorities and goals of government and its people

• When government spends more than it collects, it must borrow money

• Deficit spending increases the national debt

Mandatory Expenses

• Payments that must be made, even if the government must borrow money to do so

• Make up more than 60 percent of federal government’s budget

• Include entitlement programs and interest on the national debt

• Entitlement programs:

• ______________________________________________________

• ______________________________________________________

• ______________________________________________________

• ______________________________________________________

• ______________________________________________________

• ______________________________________________________

• ______________________________________________________

Discretionary Taxes

• An expense that can be adjusted according to needs and revenues

• Include national defense expenses

• Include nondefense expenses:

– ______________________________________________________

– ______________________________________________________

State and Local Government Spending

• Taxation and government spending vary widely between states and between cities

• Most state and local government revenues come from

– ______________________________________________________

– ______________________________________________________

– ______________________________________________________

Types of Taxes

• ____________________—paid directly to government by taxpayers

• ____________________—imposed on one party, but paid by another

• ____________________—imposes a higher tax rate on those with higher incomes

• ____________________—has effect of imposing a higher tax rate on those with lower incomes

• ____________________—imposes same tax rate on all regardless of income differences

What is taxed?

• Personal income tax—____________________

• Purchase tax—____________________

• Excise tax—_____________________________________________________________________

• Property tax—__________________________________________________________________

• Wealth tax—____________________

Paying Income Taxes

• Internal Revenue Service (IRS) collects federal income taxes

• State tax returns are filed with departments of revenue in states that collect taxes

Your Employers’ Role

• Employees fill out Form W-4

• Employers withhold taxes from employees’ paychecks

• At start of year, employers mail Form W-2 to employees

• Form W-4—taxes withheld depend on earnings and number of allowances claimed

• Form W-2—previous year’s pay and tax deductions are given

Preparing Your Return

• Each year taxpayers must file a tax report with the government showing the taxes owed

• Choose one of three common forms: 1040EZ, 1040A, or 1040

Choosing a Tax Form

• Use Form 1040, long form,

– _____________________________

– when adjustments to income, itemized tax deductions, and tax credits can reduce taxes

• Use short forms, 1040A or 1040EZ, if

– _____________________________

– _____________________________

Figuring Taxable Income

• Calculate gross income based on Forms W-2 and 1099s

• Calculate adjusted gross income by subtracting adjustments from total income

• Subtract allowable exemptions and deductions

Figuring Taxes Owed

• IRS tax tables show taxes owed based on taxable income

• Reduce the amount owed with tax credits

Filing on time

• Filing deadline for federal taxes and most state taxes is April 15

• _____________________________—falsely reducing taxes

• _____________________________—failing to declare all income or falsifying documents

State and Local Tax Forms

• _____________________________

• Taxpayers in states that collect personal income taxes must submit state tax forms

Electronic Filing

• Advantages of filing tax returns online:

– _____________________________

– _____________________________

• TeleFile allows taxpayers to file simple tax returns with touch-tone phones

Sources of Tax Information and Assistance

• The IRS answers tax questions through free booklets, recorded messages, and a Web site

• Tax preparation services fill out tax forms for a fee

• Many taxpayers use tax preparation guides and software

IRS Audits

• A detailed examination of taxpayer’s tax returns by the IRS

• During audit, taxpayers must answer IRS’s questions and provide documentation when asked

• Taxpayers have legal protections in their dealings with the IRS

Tax System Reform

• Legislators make laws that

– _____________________________

– _____________________________

– _____________________________

– _____________________________

Tax Legislation

• Many citizens are concerned about rising taxes

• Questions asked when tax policy changes:

– Will revenues generated by the new tax exceed administration costs?

– Will it be fair to all taxpayers?

– Will it impact the economy negatively?

Paying Social Security Taxes

• FICA taxes calculated as a percentage of income; deducted from gross pay

• Employers and workers split FICA taxes

– Employees pay 6.2 percent for Social Security and 1.45 percent for Medicare

– Employers contribute an additional 7.65 percent

• The self-employed pay all FICA taxes themselves

• Federal government receives FICA contributions and credits them to employees’ accounts

Your Social Security Number

• Social Security Administration uses SSNs to keep records of earnings; records determine benefit amounts

• _____________________________

• _____________________________

• _____________________________

Social Security Benefits

• If you work, your Social Security taxes pay for benefits others receive

• When you no longer work (retire, become disabled, or die), you and your dependents will get benefits provided by other workers’ Social Security taxes

• Types of benefits:

• _____________________________

• _____________________________

• _____________________________

• _____________________________

• _____________________________

• _____________________________

Social Security System Reform

• Benefits paid out will soon exceed tax collection

• Social Security fund will be depleted; no money to pay benefits of workers paying into the system now

• Taxes may have to be raised, benefits decreased, or both

Central Ideas of the Chapter

• ____________________________________________________________________________________________________________________________________________________________

• ____________________________________________________________________________________________________________________________________________________________

Vocabulary:

• ________________________ Money added to an employee’s base pay. It is usually a reward for performance or a share of business profits.

• ________________________Income paid as a percentage of sales made by a salesperson. • ________________________Payment and benefits received for work.• ________________________A limitation that affects a person’s ability to function in major life activities. • ________________________Income from employment.

• _____________________________________________________A tax-deferred investment program that helps employees save for retirement.

• ________________________A form of nonmonetary compensation received in addition to a wage or salary.

• ________________________A government payment or benefit promised by law to eligible citizens, such as Social Security and Medicare benefits, unemployment benefits, veterans’ services, food stamps, and housing assistance.

• ________________________. A tax benefit that reduces the amount of income a person is taxed on.

• __________________________________________________The law that requires the collection of social security payroll taxes.

• ________________________A Wage and Tax Statement that states the amount an employee was paid in the previous year. It also gives the amounts of income, Social Security, and Medicare taxes withheld from an employee’s income during the year.

• ________________________The Employee’s Withholding Allowance Certificate that tells the employer how much tax to withhold from an employee’s paycheck.

• ________________________ A worker’s earnings before deductions.

• ________________________Payments from financial institutions, businesses, and government to use customers’ money.

• ________________________A government program administered by the states that pays certain health care costs for eligible low-income individuals and families.

• ________________________A federal government program that helps pay the medical expenses of people 65 and older and others with certain disabilities.

• ________________________The lowest hourly wage employers can pay most workers by law.

• ________________________Gross income (plus bonuses) minus payroll deductions.

• ________________________An amount subtracted from gross income.

• ________________________A wage that is based on a rate per unit or item completed.

• ________________________Payment for work that is expressed as an annual figure.

• ________________________The federal government’s program for providing income when earnings are reduced or stopped because of retirement, disability, or death.

• ________________________An amount that can be subtracted from the taxes a worker owes, if eligible.

• ________________________An expense that can be subtracted from a worker’s taxable income.

• ________________________Money paid for service beyond what is required.

• ________________________Earnings from sources other than work.

• ________________________A payment in exchange for an employee’s labor or services. The payment, which is usually in money, is paid by the hour, day, or by the piece.