2. Managing Your Money
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3. Unit 4E
Income Taxes
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4. It is quite possible that no one fully understands federal income taxes.
The complete tax code consists of thousands of pages of detailed regulations.
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5. 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.
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6. 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
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7. 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
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8. 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
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9. 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.
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10. 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?
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11. 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).
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12. 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.
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13. 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.
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14. 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.
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15. 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
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16. 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?
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17. 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
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18. 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
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19. 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)
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20. 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
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21. 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?
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22. 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
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23. 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?
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24. 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
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