Paying Taxes
CHAPTER 6
Learning Objectives
1.Describe the basic principles of taxation and the major categories oftaxes
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 CATEGORIESOF TAXES
Gross Pay vs. Net Pay
Gross Pay
Total amount of money a worker earnsin a pay period
Hourly wages multiplied by the hoursworked
Or salary if you have it
Net Pay
Total amount of money a worker takeshome in a pay period
aka take-home pay
Money you get after paying taxes andother 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) andredistributing it to another part
Repricing – taxes can sometimes be used to make items more expensiveresulting in people not wanting to use that item (cigarettes)
Representation – people expect government to serve their needs in returnfor their financial support
Tax Basics
TAX is money collected by government from its citizens for the purpose ofoperating 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, publicschools, Social Security, welfare are all paid for through TAX REVENUE
Tax Basics
Sales Tax
Done when making a purchaseat a store
The merchant collects the moneyand then sends it to thegovernment
Done through STATE and notFEDERAL
Real Estate Tax
Calculated by the governmentbased on the value of theproperty
Primarily used to fund localschools
They increase property taxes toprovide better school facilities
Payroll Tax
You pay every time you get paid
Federal and state taxes withheldfrom a person’s paycheck andsent to the government by his/heremployer
FICA withheld as well
1. Social Security
2. Medicare
Pay Stub Shows:
Employee’s gross pay for theperiod
Amount withheld fromemployee’s gross pay for FICAand other payroll taxes
Employee’s net earnings forthe year
The Internal Revenue Service
The IRS is the government body that enforces federal tax laws andcollects 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 withthe 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
Example
1040EZ 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 InsuranceContribution 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 tothe government
Social Security and Medicare
Social Security
Provides payment to eligible retireesand disabled people
Typically equal to 4.20% of your salary
Medicare
Provides health care coverage tomost older Americans and someyounger disabled people
Health insurance provided bygovernment 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 incometax)
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 taxrates 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 uponsomeone 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 allof 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 showwinnings, 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 totalincome and subtracting allowableamounts (contributions to certainretirement accounts, alimonypayments, interest paid on studentloans, and other expenditures that areidentified 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 areallowed to deduct from their AGI toreduce their tax liability
Varies according to your filing statusand whether you’re over the age of65
Itemized Deduction
Specific expenses that can bededucted from income to reduce theamount of income subject to incometax
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 needto 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 theform of an Earned Income Credit than was withheld from their paychecks
In most cases, you will not receive an income tax return refund unless youpay taxes during that year
Objective 4:
Understand how taxes affect yourfinancial plan
•Goal: Take steps to lower their taxliability (what they owe) to thelowest possible level for their income
•You get to keep more of your ownmoney rather than pay it to thegovernment in taxes