1. Understanding Income Taxes: Federal, State, and Local

2. Objectives Determine correct filing status Differentiate between standard and itemized deduction Define personal exemption amount Define Adjusted Gross Income, Taxable Income, Deductions and Credits.

3. Purpose of Income Taxation Local, State and Federal governments collect income taxes to help pay for various benefits and services to citizens – including yourself. – Deducted from wages – Estimated payments Paying taxes is the price we pay for living in a civilized society. Oliver Wendell Holmes, Jr.

4. Income Tax Rates Local – 1 to 1.5% or earned income determined by your municipality Pennsylvania State – 3.07% most sources of income Federal – all income from whatever sources derived less deductions, adjustments and credits. Graduated system (different tax rates apply to different ranges of income) 0%, 10%, 15%, 25%, 28%, 33%, 35%

5. 5 Steps to calculating Federal Income Taxes 1.Determine Gross Income 2.Calculate AGI (Adjusted Gross Income) 3.Calculate Taxable Income 4.Determine Tax liability 5.Subtract tax credits and pre-payments to determine tax refund or balance due

6. 1. Gross Income IRS definition: “All income from whatever source derived” – Wages, tips, bonuses – Interest, dividends, capital gains – Rent – Lease – Royalties

7. 2. Determine AGI Adjusted Gross Income Even if you don’t itemize you can still benefit from certain deductions e.g. : Educator expenses IRA contributions Tuition and Fees Alimony Student Loan Interest Business loss

8. 3. Calculate Taxable Income Subtract from AGI the larger of the Standard Deduction or Itemized Deduction for your filing status You can itemize: mortgage interest, real estate taxes, income taxes paid, unreimbursed medical and dental expenses that exceed 7.5% of your AGI, work related expenses, charitable contributions, etc.

9. 3. Calculate Taxable Income cont’d 2008 Standard Deduction Filing StatusDeduction Amount Single$5,450 Married Filing Jointly, Qualified Widow(er) $10,900 Head of Household$8,000 Married Filing Separately$5,450 Higher Standard Deduction Age > 65 Add’l $1,050 each taxpayer and spouse

10. 3. Calculate Taxable Income cont’d Finally, subtract exemptions for household members at $3,500 Example: Family of 4 MFJ using standard deduction with gross income of $80,000 $80,000 -$10,900 Standard Deduction -$14,000 Exemptions $55,100 Taxable Income

11. 3. Calculate Taxable Income cont’d Example: Single person using standard deduction with gross income of $80,000 $80,000 -$5,450 Standard Deduction -$3,500 Exemptions $71,050 Taxable Income

12. 4. Calculate Gross Tax Using Tax Tables 10%15%25% Single$8,025- $32,550 $32,551- $78,850 $78,851- $164,550 Married Filing Jointly – Qualifying Widow(er) $16,050- $65,100 $65,101- $131,450 $131,451- $200,300 Head of Household $11,450- $43,650 $43,610- 112,650 $112,651$- 182,400 Married Filing Separate $8,025- $32,550 $32,551- $78,850 $78,851- $164,550

14. 5. Subtract Tax prepayments – Paycheck withholding – Estimated tax payments Tax credits – Earned Income Tax Credit – Additional Child Tax Credit – Other credits

15. Impact of Income on Taxation of Social Security Benefits Total all sources of income: – 50% of Social Security – Taxable income – Tax-Exempt income Compare to Base Amount of filing status – S, MFS, HOH $25,000-$34,000 50% is taxed > $34,000 – 85% of SS benefits taxable – MFJ $32,000-$44,000 50% is taxed > $44,000- 85% of SS benefits taxable

16. End Result Positive number = tax refund Negative number = tax balance due Penalties and interest may be charged for significant underpayment

17. Tax Avoidance vs. Tax Evasion Avoidance – using tax code to legally pay the least amount of taxes owed. – Ex. Traditional IRA or 401(k) contributions. Evasion – illegal underpayment of taxes due – willfully and deliberately not paying taxes owed the government.

18. Tax Avoidance Tools Retirement Plans U.S. Savings Bonds Municipal Bonds Charitable Contributions 529 College Savings Plans

19. Using Retirement Plans to shelter income from taxes Employer Tax-Deferred Savings Plan (401(k)s, 403(b)s, etc. Individual Retirement Account (IRA) if you qualify contributions are considered an adjustment to income (reducing your taxable income) Age limits Income limits

20. U.S. Savings Bonds Promissory notes issued by the federal government. $20,000 limit per person/year. Income earned is exempt from state and local taxes – State doesn’t tax income from federal debt – Federal government doesn’t tax income from state debt Earnings are federally tax-deferred for life of bond – up to 30 years EE bonds and I bonds (inflation adjusted)

21. Municipal Bonds Municipal bonds -= long term debt issued by local government and agencies – Proceeds finance public projects such as schools, parks, roads, bridges – Purchased individually or in mutual funds – Interest received is free from state and federal tax if issued by Pennsylvania governments

22. Charitable Contributions Benefits charity and donor Consult advisors – legal, financial and tax prior to taking action

23. Charitable Contributions cont’d Tax deductibility: – IRS definition “qualifying charity” – Certain limitations apply – Type of donation Outright gift Charitable lead trust Charitable remainder trust Charitable gift annuity – Understand the benefits and consequences of each type of donation before making a decision.

24. 529 College Savings Plans Contributions PA state tax deductible up to $______ Earnings grow federal and state income tax deferred Tax-free if proceeds used to fund qualified education expenses

25. The Pennsylvania State University is committed to the policy that all persons shall have equal access to programs, facilities, admission, and employment without regard to personal characteristics not related to ability, performance, or qualifications as determined by University policy or by state or federal authorities. It is the policy of the University to maintain an academic and work environment free of discrimination, including harassment. The Pennsylvania State University prohibits discrimination and harassment against any person because of age, ancestry, color, disability or handicap, national origin, race, religious creed, sex, sexual orientation, or veteran status. Discrimination or harassment against faculty, staff, or students will not be tolerated at The Pennsylvania State University. Direct all inquiries regarding the nondiscrimination policy to the Affirmative Action Director, The Pennsylvania State University, 328 Boucke Building, University Park, PA 16802-5901, Tel 814-865-4700/V, 814- 863-1150/TTY.