1. Chapter 7
Federal Income Tax

2. Objectives
Understand the purpose of taxes, different types of taxes, and the history of taxes in the United States.
Describe components of the tax system, including the IRS, the power to tax, and paying your fair share
Define and show a working knowledge of exemptions, dependents, and taxable and nontaxable income when preparing tax returns
Prepare forms 1040EZ and 1040A (Individual Federal Income Tax Returns).

3. Our Tax System
Money is collected by the government from citizens and businesses in the form of taxes
This money, which is called revenue, is redistributed according to needs and priorities determined by Congress
Ability-to-pay principle: individuals with different amounts of wealth or income should pay different amounts of taxes

4. Our Tax System cont’d Types of taxes Progressive Regressive
Increase in proportion to income
People/Businesses with higher income pay not only higher taxes, but at a higher rate
Regressive
Decrease in proportion to income
People/Businesses with higher income pay taxes at a decreased percentage
Ex. Sales Tax
Proportional
Rate remains constant even if though the amount being taxed increases
Ex. Property Tax

5. Our Tax System cont’d Local Taxes National Taxes
Pay for education, parks and recreation, streets and roads, police, fire, and health departments
National Taxes
Pay salaries for Congress
Pay for national defense, highways, parks, welfare, foreign aid, etc.
Most services (local and national) are provided for the general welfare of all citizens, although as an individual, you may not benefit directly

6. History of Taxes
Constitution (1787) included the option to tax, but not to tax individuals directly
Excise taxes and customs duties produced enough revenue at the time
No income taxes against citizens, but also no services for them either
Revolutionary War financed by other countries
War of 1812 was first temporary income tax
When war debts were paid, income tax was dropped
Civil War
1862-President Lincoln signed a law providing for progressive income tax on wages
When the war ended the tax expired
16th Amendment (introduced 1909, ratified 1913)
1st permanent income tax

7. History of Taxes cont’d
WWI (1917) was paid for by income taxes
After WWI government was not providing many services for citizens
Great Depression (1929)
President Roosevelt’s “New Deal” provided for government services for citizens through tax revenue
Social Security Act (1935)
Internal Revenue Service (IRS) created
Money withheld from wages deposited with the Dept. of Treasury
During WWII taxes were increased to finance the war
This increase set precedent for changing tax rates of today
Rates are increased to pay for growing services and needs of the government

8. Components of the Tax System
IRS
Administrative agency of the Dept. of Treasury
Headquarters in DC, 7 regional offices
Main functions are to collect income taxes and enforce tax laws
Other functions include:
Assist taxpayers in finding information and forms
Assist taxpayers in preparing tax returns

9. Components of the Tax System (cont’d)
Power to Tax
Rests with Congress
Bills originate in the House per the Constitution
House Ways and Means Committee makes recommendations to the full House
After being passed by the House, bills must be passed by Senate, then signed by the President to become law

10. Components of the Tax System (cont’d)
Paying Your Fair Share
US income tax is set at a graduated rate
More income received = more income tax
Rates increased as Congress seeks ways to balance budget and reduce national debt
US system based on voluntary compliance
All citizens are expected to file income tax returns by April 15, no tax collectors
Late filing can result in penalty, interest charges, fine, and/or imprisonment
Willful failure to pay taxes is called tax evasion, a felony punishable by fine and/or imprisonment

11. Components of the Tax System (cont’d)
IRS Audit
When the IRS reviews tax returns of an individual or business
Three choices if called for an audit
Self-representation
Give power of attorney to a lawyer, CPA, immediate family member, enrolled agent (someone formerly employed by the IRS at the audit level for >= 5 years)
Take anyone at all with them for support (tax preparer, therapist, etc) during the audit session
Most audits involve nothing more than confirming supporting documentation (receipts, bank statements, etc) so it can be done by the taxpayer w/out outside help

12. Tax Form Terms Filing Status Single (not married)
Married filing jointly
Married filing separately
Head of Household (must meet certain conditions)
Qualifying widow(er) w/ dependent child

13. Tax Form Terms cont’d Exemption(s) Dependent
An allowance(s) a taxpayer claims for each person dependent on taxpayer’s income
Automatically allowed 1 for yourself
Dependent
A person who lives w/ you and receives > ½ of living expenses from you (including baby born at any time during the tax year)
Each exemption claimed excludes a certain amount of gross income ($3,100 in 2004)

14. Tax Form Terms cont’d Qualifications for being a dependent
Must be a relative
Citizen or resident of the United States
If married, cannot file a joint return w/ spouse
Person’s income must be less than the amount of exemption (does not include child <19 or student <24)
Must provide > ½ of the person’s support during the year

15. Tax Form Terms cont’d Gross Income Adjusted Gross Income
All the taxable income received, including wages, tips, salaries, interest, dividends, unemployment compensation, alimony, workers’ compensation, etc
Adjusted Gross Income
Income after allowed adjustments are made (i.e. IRA contributions)
Taxable Income
Income used for determining tax amount
AGI less legal expenses that are allowed to be deducted (state and local taxes, mortgage interest, child care expenses, casualty and theft losses, job and miscellaneous expenses)

16. Preparing to File Who must file? When to file? Short Form or Long Form
You must file if your filing status, age, and gross income are shown in Fig 7-3 on page 162
When to file?
April 15th
The earlier you file, the sooner you get your refund
Short Form or Long Form
17% use 1040EZ
requirements
19% use 1040A
64% use 1040
Must use if you cannot file one of the others

17. Summary Income taxes are the US government’s largest source of income
Income taxes did not always exist, but evolved to finance wars
3 types of taxes: progressive, regressive, proportional
IRS collects taxes
Citizens voluntarily comply with tax laws
Gross income – adjustments = AGI
AGI – itemized deductions/standard deduction – exemptions = taxable income
If your standard deduction is less than your itemized deduction, you must use form 1040
Willful failure to prepare and file tax returns is a federal offense

18. Important Dates 1787 – US Constitution 1812 – War of 1812
Included option to tax but not tax individuals directly
1812 – War of 1812
1st temporary income tax
1862 – Pres. Lincoln signed bill into law providing for temporary progressive tax
1913 – 16th Amendment
1st permanent income tax (progressive)
1917 – WWI paid for by income taxes
1929 – Great Depression/FDR’s New Deal
Prosperity through taxation and redistribution of income
1935 – Social Security Act
Created the Internal Revenue Service

19. 1040A requirements
return

20. 1040EZ requirements
return