Managing Your Money Copyright © 2011 Pearson Education, Inc.

Unit 4E Income Taxes Copyright © 2011 Pearson Education, Inc.

It is quite possible that no one fully understands federal income taxes. The complete tax code consists of thousands of pages of detailed regulations. Copyright © 2011 Pearson Education, Inc.

Income Tax Preparation Flow Chart Steps in a basic tax calculation This flow chart makes all the difference in the world when students are trying to figure out what to do next in the tax filing process. Working through some practical scenarios will make for interesting discussions and calculations. Copyright © 2011 Pearson Education, Inc.

Definitions Adjusted gross income – subtracting adjustments from your gross income (untaxed portions of gross income are called adjustments) Exemptions & Deductions – amounts subtracted from adjusted gross income before calculating taxes Taxable income – once you subtract the exemptions and deductions, this is what you are left with Total tax – after subtracting the amount of any credits you find this (ie: child tax credit) Tax refund – what you receive if you have paid more than you owe in taxes Copyright © 2011 Pearson Education, Inc.

Income on Tax Forms CN (1-3) Karen earned wages of $34,200. received $750 in interest from a savings account, and contributed $1200 to a tax deferred retirement plan. She was entitled to a personal exemption of $3650 and to deductions totaling $5900. Find her: 1. Gross income 2. Adjusted gross income 3. Taxable income Copyright © 2011 Pearson Education, Inc.

Filing Status Tax calculations depend on your filing status, which consist of the following four categories: Single – unmarried, divorced, or legally separated Married filing jointly – married and you and your spouse file a single tax return Married filing separately – married and you and your spouse file two separate tax returns Head of household – unmarried and paying more than half the cost of supporting a dependent child or parent Copyright © 2011 Pearson Education, Inc.

Exemptions and Deductions Both exemptions and deductions are subtracted from your adjusted gross income. Exemptions are a fixed amount per person. Exemptions can be claimed for you and each of your dependents. Deductions vary from one person to another. A standard deduction depends on your filing status. An itemized deduction is the sum of all the individual deductions to which you are entitled. Copyright © 2011 Pearson Education, Inc.

Should you Itemize? CN (4) Suppose you have the following deductible expenditures: $2500 for interest on a home mortgage, $900 for contributions to charity, and $250 for state income taxes. Your filing status entitles you to a standard deduction of $5700. 4. Should you itemize your deductions or claim the standard deduction? Copyright © 2011 Pearson Education, Inc.

Tax Rates A progressive income tax means that people with higher taxable income pay at a higher tax rate. Marginal tax rates are assigned to different income ranges (or margins). Copyright © 2011 Pearson Education, Inc.

2006 Marginal Tax Rates, Standard Deductions, and Exemptions This flow chart makes all the difference in the world when students are trying to figure out what to do next in the tax filing process. Working through some practical scenarios will make for interesting discussions and calculations. Copyright © 2011 Pearson Education, Inc.

Marginal Tax Computations CN (5-7) Using 2009 rates, calculate the tax owed by each of the following people: 5. Deirdre is a single with no dependents. Her adjusted gross income is 90,000 6. Robert is a head of household taking care of two dependent children. His adjusted gross income also is 90,000 7. Jessica and Frank are married with no dependents. They file jointly. The each have $90,000 in adjusted gross income. Copyright © 2011 Pearson Education, Inc.

Tax Credits and Deductions As a rule, tax credits are more valuable than tax deductions. A tax credit reduces your total tax bill by the full amount of the credit. A tax deduction reduces your taxable income by the amount of the deduction. Copyright © 2011 Pearson Education, Inc.

Tax Credits vs. Tax Deductions Example: Suppose you are in the 25% tax bracket. How much does a $1000 tax credit save you? How much does a $1000 charitable contribution (which is tax deductible) save you? (Assume itemized deductions.) Solution: Tax credit – $1000 is deducted from your tax bill $1000 is saved Tax deduction – taxable income reduced by $1000 is saved Copyright © 2011 Pearson Education, Inc.

Rent or Own? CN (8) Suppose you are in the 28% tax bracket and you itemize your deductions. You are trying to decide whether to rent an apartment or buy a house. The apartment rents for $1400 per month. You’ve investigated your loan options and you’ve determined that if you buy the house, your monthly mortgage payments will be $1600, of which an average of $1400 goes toward interest during the first year. Is it cheaper to rent the apartment or buy the house? Copyright © 2011 Pearson Education, Inc.

Varying Value of Deductions CN (9-10) Drew is in the 15% marginal tax bracket. Marian is in the 35% marginal tax bracket. They each itemize their deductions. The each donate $5000 to charity. Compare their true costs for the charitable donation. 9. Drew 10. Marian Copyright © 2011 Pearson Education, Inc.

Social Security and Medicare Taxes Some income is subject to Social Security and Medicare taxes, which are collected under the name FICA (Federal Insurance Contribution Act) taxes. FICA applies to the following: Income from wages (including tips) Self-employment FICA does not apply to the following: Income from interest Income from dividends Profits from sales of stock Copyright © 2011 Pearson Education, Inc.

FICA Taxes CN (11) In 2009, Jude earned $22,000 in wages and tips from her job waiting tables. Calculate her FICA taxes and her total tax bill including marginal taxes. 11. What is her overall tax rate on her gross income, including both FICA and income taxes? (assume she is single and takes the standard deduction) Copyright © 2011 Pearson Education, Inc.

Dividends and Capital Gains Income with special tax treatment: Dividends (on stocks) Capital gains – profits from the sale of stock or other property Short-term capital gains – profits on items sold within 12 months of their purchase Long-term capital gains – profits on items held for more than 12 months before being sold Copyright © 2011 Pearson Education, Inc.

Dividend and Capital Gains Income CN (12-13) In 2009, Serena was single and lived off an inheritance. Her gross income consisted solely of $90,000 in dividents and long-term capital gains. She had no adjustments to her gross income, but had $12,000 in itemized deductions and a personal exemption of $3650. 12. How much tax does she owe? 13. What is her overall tax rate? Copyright © 2011 Pearson Education, Inc.

Tax-Deferred Income Tax-deferred savings plans allow you to defer income taxes on contributions to certain types of savings plans. These include the following: Individual retirement accounts (IRAs) Qualified retirement plans (QRPs) 401(k) plans Copyright © 2011 Pearson Education, Inc.

Tax-Deferred Savings Plan CN (14) Suppose you are single, have a taxable income of $65,000, and make monthly payments of $500 to a tax-deferred savings plan. 14. How do the tax-deferred contributions affect your monthly take-home pay? Copyright © 2011 Pearson Education, Inc.

Homework 4E P.276 Review Questions 1-10 Does it make sense 11-18 1 web (63-65) 1 world (66-68) Class Notes 1-14 Copyright © 2011 Pearson Education, Inc.