1. Tax Preparation
Financial Literacy

2. Federal Income Tax Structure
The Federal income tax is a progressive tax
The higher your income, the more you pay, both as a dollar amount and as a percentage.
Tax Freedom Day (see Facts of Life, page 102)
Almost four months of your yearly income goes to pay various taxes (30%)

3. Tax Vocabulary Tax Brackets: Personal Exemptions:
Income ranges in which the same tax rates apply
For example: 15%, 25%, 35%, etc.
Personal Exemptions:
An allowed reduction in your income before taxes are computed
You get one for yourself, one for your spouse, and one for each dependent

4. Tax Vocabulary, continued
Deductions are:
Expenses that reduce taxable income, such as:
Some medical expenses
Mortgage interest paid
State and local income taxes
Charitable contributions
Itemized Deductions (expenses):
Deductions are calculated using Schedule A

5. Tax Vocabulary, continued
Standard Deduction:
A set deduction allowed by the IRS regardless of your actual expenses
You can itemize deductions or take the standard deduction, but not both
Taxable Income:
Income subject to taxes after deductions and exemptions are subtracted from gross income

6. Tax Example Gross income – exemptions – deductions = Taxable Income
Assuming you are married filing jointly with gross income of $70,000 and taxable income of $49,423, your taxes would be $6,564 (see Figure 4.4 on page 109)

7. Marginal Tax Rate
This chart shows the highest tax rates charged for the highest incomes over the last 100 years.
The Fiscal Cliff agreement raised the highest tax rate to 39.6% on the highest earners

8. Average vs Marginal Tax Rates
Marginal tax rates are the percentage paid on your highest level of income
Marginal tax rate in the example is 25%
Average tax rates are your actual taxes divided by your taxable income (will be lower than the marginal rate):
$6,564/$49,423 = 13.28%
Or by your gross income:
$6,564/$70,000 = 9.38%

9. Filing Status Single: Married filing jointly:
You are single at the end of the year with no dependents
Married filing jointly:
You and your spouse combine incomes
Married filing separately:
You and your spouse file separate returns
Head of Household:
You are unmarried but have at least one dependent child living with you

10. Other Taxes You Pay Social Security (FICA)
6.2% for Social Security
1.45% for Medicare
State and local income taxes
Excise taxes:
Sales taxes, gas taxes, property taxes, taxes on liquor, cigarettes, jewelry, air travel, etc.
Gift and estate taxes

11. Who Has To File A Return? If your income is greater than $20,900
If it is less than that, you might not need to file, depending on your circumstances (check with your tax advisor)
However, if your income is less than that and if you had taxes withheld, you will not get a refund unless you file a return.

12. Itemizing Deductions The most common deductions are:
Medical and dental expenses exceed 7.5% of adjusted gross income
Tax expenses (state and local can be deducted, but not Federal, Social Security, or sales taxes)
Home mortgage interest
Charitable contributions
Casualty and theft losses
A deduction will lower your tax bill, but not dollar for dollar

13. Standard Deduction
The standard deduction is the government’s best estimate on what the average person would be able to deduct by itemizing
Remember that you can take the standard deduction or you can itemize, but not both
See Figure 4.2 for standard deduction amounts (page 106)

14. Exemptions Personal Dependents:
Take one for yourself and one for your spouse
Dependents:
Must have a qualifying relationship (child, grandchild, parents, stepparents, uncles, nieces, etc.)
The dependent can’t earn more than the exemption amount does not apply to children under 19 or to children under 24 if full-time students
Must provide more than half of dependent’s financial support

15. Tax Formula
Adjustments to gross income: tax-deductible expenses and retirement contributions (IRA, 401K), moving expenses, etc.
Gross Income: Sum of Income from all sources
Less
Equals
Adjusted Gross Income
Less
Equals
Exemptions and deductions
Taxable income

16. Calculating Your Base Income Tax
For most taxpayers, this is calculated using tax tables (see page 109)
Tax tables have tax brackets built in
Once taxes have been calculated, credits can be deducted

17. Common Income Tax Credits
Tax credits will lower your tax bill, dollar for dollar. Examples:
Child Tax Credit (this can become a refund for parents who don’t pay taxes) up to $1000 per child
American Opportunity Credit
Credit for tuition, up to $2500 of the first $4,000 of educational expenses
Child and dependent care credit
Credit for money paid for child or other dependent care
Earned income credit
For low-income families, may result in negative taxes paid

18. Income Tax Due Base Income Tax Tax Credits Total Income Tax Due Less
Equals
Total Income Tax Due

19. Picking a Tax Form Options: 1040EZ, 1040A, or 1040 1040EZ: 1040A:
No dependents, taxable income less than $50,000, no itemizing deductions
1040A:
No itemizing, alimony, capital gains, pension or Social Security benefits; income less than $50,000
1040: everyone else