Chapter 7 Federal Income Tax

Federal Income Taxes 1.Used to pay for government services from national defense to highways and parks 2.Are paid by all those who receive income – businesses, individuals, trusts, institutions and so on 3.Are progressive taxes – the more you earn, the more you pay 4.Are approved and changed by Congress and the President of the United States 5.Are collected by the Internal Revenue Service (IRS) 6.Are based on all people voluntarily filing their tax returns and paying their fair share of taxes

Federal Income Taxes 7.Are determined by a tax return filled out by April 15 of each year, based on:  Gross income (wages, interest, tips, and so on)  Less adjustments for allowed retirement plans and alimony  Less deductions (or standard deduction) and exemptions  Less any credits

Taxes In a free enterprise system, the government collects money from citizens and businesses in the form of taxes (called revenue). Largest source of government revenue is income taxes.

Taxes Other taxes providing government revenue include:  Social security taxes, unemployment insurance taxes, inheritance and estate taxes, excise taxes, import taxes, and personal property taxes. A commonly accepted principle of tax fairness is that individuals with high incomes should pay more taxes than people with low incomes (called ability- to-pay principle).

Types of Taxes  Progressive taxes  Regressive taxes  Proportional taxes

Progressive Taxes Taxes that take a larger share of income as the amount of income grows. Example: federal income taxes

Regressive Taxes Taxes that take a smaller share of income as the amount of income grows. Example: sales tax, consumption taxes Excise taxes are sales taxes imposed on specific goods and services, such as gasoline, cigarettes, alcoholic beverages, air travel, and telephone service.

Regressive Taxes Purchase an item for $10 at 5% sales tax. Cost is $10.50 Worker who earns $50 per week.50/50 =.01 or 1% Worker who earns $100 per week.50/100 =.005 or.5%

Proportional Taxes/Flat Taxes Taxes for which the rate stays the same, regardless of income. Example: Property taxes

Why Pay Taxes? 1.Taxes give the federal government money to provide all citizens with services they could not provide individually or locally such as:  National defense  National weather service  National parks and recreation sites  Interstate highways  Regulations and agencies to enforce safety and health standards  Student loans and aid programs  Relief when disasters strike (hurricanes, earthquakes, and floods)

Why Pay Taxes? 2.Taxes collected on the state and local level provide the following benefit to the state and local population:  Education  State welfare programs  Streets, roads, and state highways  Police, fire, and health departments  Local recreation, safety, and service progams

Components of the Tax System  The IRS  The power to tax  Paying your fair share  Tax brackets  Tax evasion

IRS  An agency of the Department of Treasury.  HQ in Washington, D.C. with 7 regional offices  Main function of the IRS are to collect income taxes and to enforce tax laws

Power to Tax  Power to levy taxes rests with Congress.  Constitution provides that “all bills for raising revenue shall originate in the House of Representatives.”

Paying Your Fair Share  Income tax system is graduated – tax rates increase as taxable income increases.  Tax rates apply to income ranges or tax brackets  Currently 6 tax brackets (10, 15, 25, 28, 33, 35%)  Deficit or shortage – when government pends more than it receives in revenue  Voluntary compliance – all citizens are expected to prepare and file income tax returns  Tax evasion – Willful failure to pay taxes

IRS Audit  Examination of their tax returns. Three choices:  Represent themselves  Give someone the power to take their place  Bring anyone to all for support during the session  Types of audit  Correspondence audit – IRS sends a letter, asking the taxpayer to respond to specific questions or produce evidence of deductions or other entries on the tax return.  Field audit – An IRS agent or local representative visits the taxpayer to verify information or ask specific questions.

Lesson 7.2 Filing Tax Returns  Define tax vocabulary.  Prepare tax Forms 1040EZ and 1040A.

Filing Status  Single person  Married person filing a joint return  Married person filing a separate return  “Head of household”  Qualifying widow(er) with a dependent child

Exemptions  Personal exemption  Dependent exemption

Gross Income  Wages, salaries, and tips  Interest income  Dividend income  Unemployment compensation  Social security benefits  Child support  Alimony

What is not Taxable?  Child support  Gifts and inheritances  Life insurance benefits  Veterans’ benefits

Adjusted Gross Income Gross income –Adjustments Adjusted gross income

Taxable Income Gross income –Adjustments Adjusted gross income –Deductions –Exemptions Taxable income

Deductions  Itemize  Standard deduction

Tax Credits  For college tuition  For childcare to enable parents to work  For lower-income wage earners

Preparing to File  Who must file?  When to file?  Which form to use?  Where to begin?  Filing electronically

Who Files What Tax Form? 1040EZ1040A1040 Single or Married No DependentsWith Dependents & Standard Deduction With Dependents & Itemized Deductions Taxable income below $50,000 Taxable income above $50,000

Preparing Your Income Tax Return  Tax preparation software  Form 1040EZ  Form 1040A

Form 1040EZ  Step 1: Name, address, and social security number  Step 2: Report income  Step 3: Compute tax  Step 4: Refund or amount owed  Step 5: Sign the return

Form 1040A  Step 1: Name and address  Step 2: Filing status  Step 3: Exemptions  Step 4: Total income  Step 5: Adjusted gross income

Form 1040A (continued)  Step 6: Taxable income  Step 7: Tax, credits, and payments  Step 8: Refund or amount owed  Step 9: Signature