Paying TaxesCHAPTER 6

Learning Objectives

1. Describe the basic principles of taxation and the major categories of taxes

2. Explain payroll taxes

3. Discuss the purpose and process of filing tax returns

4. Understand how taxes affect your financial plan

Objective 1:DESCRIBE THE BASIC PRINCIPLES OF TAXATION AND THE MAJOR CATEGORIES OF TAXES

Gross Pay vs. Net Pay

Gross Pay Total amount of money a worker

earns in a pay period

Hourly wages multiplied by the hours worked

Or salary if you have it

Net Pay Total amount of money a worker

takes home in a pay period

aka take-home pay

Money you get after paying taxes and other deductions

Purpose of Taxation (Four Rs)

Revenue – MAIN PURPOSE – raise money the government uses for roads, schools, hospitals, etc.

Redistribution – taking wealth from one part of society (the wealthy) and redistributing it to another part

Repricing – taxes can sometimes be used to make items more expensive resulting in people not wanting to use that item (cigarettes)

Representation – people expect government to serve their needs in return for their financial support

Tax Basics

TAX is money collected by government from its citizens for the purpose of operating the government

Income taxes

Property taxes

Gas, tobacco

Businesses also pay taxes

Government uses taxes to fund governmental services/programs

National defense, fire and police, road construction/maintenance, public schools, Social Security, welfare are all paid for through TAX REVENUE

Tax Basics

Sales TaxDone when making a purchase at a store

The merchant collects the money and then sends it to the government

Done through STATE and not FEDERAL

Real Estate TaxCalculated by the government based on the value of the property

Primarily used to fund local schools

They increase property taxes to provide better school facilities

Payroll TaxYou pay every time you get paid

Federal and state taxes withheld from a person’s paycheck and sent to the government by his/her employer

FICA withheld as well

1. Social Security

2. Medicare

Pay Stub Shows:Employee’s gross pay for the period

Amount withheld from employee’s gross pay for FICA and other payroll taxes

Employee’s net earnings for the year

The Internal Revenue Service

The IRS is the government body that enforces federal tax laws and collects taxes

Branch of US Treasury Department

Congress makes law, IRS enforces law

Tax Returns

Each year you earn an income over a certain amount, you must file a federal tax return with the IRS

Generally you use a form called 1040 or 1040EZ

Purpose of a tax return – report to the IRS all the information relative to you income taxes

How much you earned from all income sources

How much you paid to IRS through withholding or estimated payments

You must figure exactly what tax you should paid for the tax year

If withholding > that number, you get a refund

If withholding < that number, you owe money

Example1040EZ form

Filing Your Taxes

Taxes are based on earnings for that calendar year (January – December)

You have until APRIL 15TH to file your tax return

Objective 2:EXPLAIN PAYROLL TAXES

Payroll Taxes

Personal payroll taxes (Federal and State)

Also includes Social Security and Medicare (aka FICA – Federal Insurance Contribution Act)

In some cases, FICA (Medicare and social security) is known as OASDI (Old-Age, Survivors, and Disability Insurance)

Employers match employee’s contribution to FICA and sends that amount to the government

Social Security and Medicare

Social Security Provides payment to eligible retirees

and disabled people

Typically equal to 4.20% of your salary

Medicare Provides health care coverage to

most older Americans and some younger disabled people

Health insurance provided by government for those 65+

Personal Income Taxes• Taxes imposed on the income you earn• The more money you earn, the higher the rate at which you pay taxes• You pay federal AND state (TEXAS does NOT have a state personal income

tax)

Objective 3:DISCUSS THE PURPOSE AND PROCESS OF FILING TAX RETURNS

Filing Status

You must specify a filing status when you submit you income tax return – applicable tax rates and rules will differ depending on which you choose

Single

Married filing jointly

Married filing separately

Head of household – single person who has a child

Qualifying widow(er) with dependent child

You’re considered a dependent until 18 (means you are financially dependent upon someone else) which lowers what your parent/guardian owes in taxes

You still have to file a tax return

Gross Income/Total Income

The first step in calculating the federal tax you owe is determining your GROSS INCOME

Consists of the total amount of a person's income from any source

At the end of the year your employer will send you a document called a W-2 that summarizes all of your relevant income and tax withholding information from each employer you had

Capital gains – a taxable gain that occurs when you sell an asset for more than you paid for it (example: stocks)

Gross income also includes income from tips, rental properties, business income, game show winnings, scholarship amounts

NOT a part of gross income: insurance reimbursements, child support payments, moving expenses, veteran’s and welfare benefits

Adjusted Gross Income - AGI Income calculated by taking total

income and subtracting allowable amounts (contributions to certain retirement accounts, alimony payments, interest paid on student loans, and other expenditures that are identified by the IRS)

Game Show Winnings Considered income

You must pay taxes on them

Use form 1099-MISC

Rule of thumb: you’ll have to pay 50% of what you earn in taxes

Deductions and Exemptions

Standard Deduction Fixed amount ALL TAXPAYERS are

allowed to deduct from their AGI to reduce their tax liability

Varies according to your filing status and whether you’re over the age of 65

Itemized Deduction Specific expenses that can be

deducted from income to reduce the amount of income subject to income tax

Interest paid on mortgage

Real estate taxes

Charitable donations

Large medical expenses

Refund or Payment?

Accurate completion of your tax return will show you whether you need to pay additional income taxes that year

If you overpaid you get a refund

In some cases, low income families will receive more money back in the form of an Earned Income Credit than was withheld from their paychecks

In most cases, you will not receive an income tax return refund unless you pay taxes during that year

Objective 4:Understand how taxes affect your financial plan

• Goal: Take steps to lower their tax liability (what they owe) to the lowest possible level for their income

• You get to keep more of your own money rather than pay it to the government in taxes