1. © 2012 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. Preparing Your Taxes #3

2. Learning Goals

3. Understanding Federal Income Tax Principles Internal Revenue Service (IRS) responsible for administration and enforcement of federal tax laws Typical American family pays more than 1/3 of gross income in various taxes

4. Income Taxes Major source of revenue for the federal government Personal income taxes are scaled on progressive rates.

5. Economics of Income Taxes Progressive tax structure

6. Single Taxpayer 2010 Tax Return

7. Economics of Income Taxes Marginal Tax Rate Tax rate paid on the next dollar of taxable income Average Tax Rate Rate at which each dollar is taxed on average –Divide tax liability by taxable income

8. Sam and Burt’s Taxes

9. Filing Status Categories

10. Your Take-Home Pay Taxes due on a pay-as-you-go basis –Employer withholds taxes all year –Self-employed deduct and pay taxes Taxes include: –Federal, State, & Local income taxes –FICA and other withholding taxes

11. Take Home Pay Gross Pay – amount before taxes are deducted Net Pay – “take home pay”; amount after taxes and deductions

12. Federal Withholding Amount withheld depends on both: –Amount of earnings –Number of withholding allowances you claimed on your W-4 Allowances –One for yourself –One for each dependent

13. FICA and Other Withholding FICA –Federal Insurance Contributions Act Social Security – 6.2% Medicare – 1.45% –Together make FICA Paid equally by employer & employee

14. It's Taxable Income That Matters Taxable Income = the amount of income subject to taxes Calculating income taxes is a complex process involving several steps and many computations

15. Gross Income All income subject to taxes –Wages & salaries –Bonus –Interest received –Alimony received –Farm income –Prizes, lottery winnings –Rental income ***Child support and bond interest are tax exempt and excluded

16. Three Kinds of Income Active Income Wages, salaries, bonuses, pension, alimony Interest, dividends, capital gains Portfolio Income Passive Income Income from real estate, limited partnerships

17. Taxable Income and Liability

20. Capital gain (loss) – when an asset is sold for more (less) than its original cost Capital Gains

21. Capital Gains Tax Categories as of 2010 Capital gains tax rates are as low as 5% or 15% for holding periods over 12 months, depending on the tax bracket (year 2010).

22. Capital Losses – page 51 Write off capital losses dollar for dollar against capital gains After that, a max of $3000 in additional losses against active income See example page 52

23. Selling Your Home – special case Tax payer must own and occupy house for at least 2 of last 5 years prior to sale Can exclude the following gain: –Single = $250,000 –Married = $500,000

24. Income remaining after subtracting allowable adjustments to income from gross income Used to limit certain itemized deductions and other calculations Adjustments to (Gross) Income

25. Adjustments to Gross Income These can be subtracted from gross income

26. Deductions: Standard or Itemized Standard deduction – a fixed amount that depends on filing status

27. Deductions: Standard or Itemized Itemized deductions specific personal expenditures itemize if expenses are greater than standard deduction Medical, dental expenses State, local, foreign taxes Mortgage interest Charitable contributions Casualty and theft losses Moving expenses

28. Exemptions Deductions from AGI based on number of persons supported by taxpayer’s income

29. Calculating Your Taxes Reported taxable income – determines the amount of income subject to federal income taxes If taxable income <$100,000 use tax rate tables If taxable income <$100,000 use tax rate tables If taxable income >$100,000 use tax schedules If taxable income >$100,000 use tax schedules

30. Tax Credits Subtracted from amount of taxes owed Credits include:

31. Taxable Income and the Amount of Taxes Due (2010)

32. Tax Credits versus Tax Deductions Which results in lower taxes? Credits directly reduce amount of taxes owed Deductions subtracted from AGI and reduce taxable income VS

33. Tax Forms and Schedules When more detail is required, taxpayers also must file other forms and schedules

34. Tax Forms and Schedules- 1040EZ Form 1040EZ -- Simple 1 page form Under age 65 Taxable income under $100,000 Don’t claim –adjustments to income –itemized deductions –tax credits

35. Continued…

37. Tax Forms and Schedule-1040 Standard Form 1040 Taxable income over $100,000 Claim itemized deductions Use when reporting self- employment income or reporting income from sale of property

38. 2010 Tax Return for the Milroys Continued…

39. 2010 Tax Return for the Milroys Continued… Back of 1040 Form

40. 2010 Tax Return for the Milroys Back of 1040 Form

41. Other Filing Considerations Quarterly payment of estimated taxes April 15 filing deadline Filing extensions Amended returns (1040X) Audited returns

42. Tax Preparation Services Do it yourself or get help from Private tax preparers –Tax services –CPA’s –Enrolled agents –Tax attorneys Computer-based tax returns Taxpayer is responsible for accuracy!

43. Effective Tax Planning Tax avoidance is legal - tax evasion is not! Reduce taxes Maximize deductions, credits Shift taxes Use gifts or trusts Defer taxes Postpone to future through IRA or annuity