1. Foundations of Personal Finance Ch. 7

2. 7
Income and Taxes

3. Objectives Identify different types of income and employee benefits.
Relate taxation to government spending.
List goods and services government provides.
Identify different types of taxes.
Identify common tax forms.
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4. Objectives Describe basic procedures for filing a tax return.
Explain the purposes and function of the Social Security system.

5. The Many Forms of Income
Income is money earned from employment and investments
Governments tax income and assets to create revenue that is used to provide public goods and services

6. Foundations of Personal Finance Ch. 7
Money Earned from Work
Income received from employment is earned income
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7. Money Earned from Work Earned income includes
wage (minimum wage for many unskilled and beginning workers)
piecework income
salary
commission
tip
bonus

8. Employee Benefits
Some of the most valuable forms of employee compensation are not monetary
Employee benefits often include
paid vacation, holiday, and sick leave
life and health insurance
employer-sponsored retirement savings plan

9. Business Profit Income
Income earned by the self-employed
Disadvantages of self-employment:
Must arrange and pay for own employee benefits; can be costly
Must pay entire Social Security and Medicare tax, rather than half the cost

10. Foundations of Personal Finance Ch. 7
Payroll Deductions
Net income (take-home pay) is gross income minus payroll deductions
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11. Payroll Deductions
Deduction can lower a paycheck by 20 percent or more
Bonuses increase gross income
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12. Payroll Deductions Common payroll deductions:
FICA (Federal Insurance Contributions Act): Social Security and Medicare
Federal withholding tax
State and city withholding taxes, if applicable
Other benefits (insurance purchased through employers)

13. Money Earned Outside Work
Unearned income—income received from sources other than employment
earnings from investments, sale of assets, and interest paid on savings and bonds
Social Security and retirement account payments
rent, inheritance, awards, gifts, alimony
unemployment compensation

14. The Importance of Taxes
Foundations of Personal Finance Ch. 7
The Importance of Taxes
Government uses its taxing authority to
generate revenue to provide goods and services for public’s benefit
stabilize the economy
address social challenges
influence behavior

15. Federal Government Spending
Limited resources force governments to make choices
A budget reflects priorities and goals of government and its people
When government spends more than it collects, it must borrow money
Deficit spending increases the national debt
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16. Federal Government Spending
Foundations of Personal Finance Ch. 7
Federal Government Spending

17. In Your Opinion
What changes should be made to the way the government spends taxpayers’ money?

18. Mandatory Expenses
Payments that must be made, even if the government must borrow money to do so
Make up more than 60 percent of federal government’s budget
Include entitlement programs and interest on the national debt
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19. Mandatory Expenses Entitlement programs: Social Security Medicare
Medicaid (for older adults and people with disabilities)
Veterans’ pensions and medical care
Nutrition and housing assistance
Unemployment compensation
Federal employee retirement benefits

20. Discretionary Expenses
An expense that can be adjusted according to needs and revenues
Include national defense expenses
Include nondefense expenses:
Costs of government operations and programs
Funds given to state and local governments

21. State and Local Government Spending
Foundations of Personal Finance Ch. 7
State and Local Government Spending
Taxation and government spending vary widely between states and between cities
Most state and local government revenues come from
personal and corporate income taxes
sales tax
real estate and personal property taxes
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22. State and Local Government Spending
Foundations of Personal Finance Ch. 7
State and Local Government Spending

23. Types of Taxes Direct—paid directly to government by taxpayers
Indirect—imposed on one party, but paid by another
Progressive—imposes a higher tax rate on those with higher incomes
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24. Foundations of Personal Finance Ch. 7
Types of Taxes
Regressive—has effect of imposing a higher tax rate on those with lower incomes
Proportional—imposes same tax rate on all regardless of income differences

25. What Is Taxed? Personal income tax—your income
Purchase tax—goods and services
Excise tax—sale and transfer of certain items, including air travel, phone service, gasoline
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26. Foundations of Personal Finance Ch. 7
What Is Taxed?
Property tax—real estate property tax and personal property tax
Wealth tax—assets (estate and gift taxes)

27. Foundations of Personal Finance Ch. 7
Paying Income Taxes
Internal Revenue Service (IRS) collects federal income taxes
State tax returns are filed with departments of revenue in states that collect taxes

28. Your Employer’s Role Employees fill out Form W-4
Employers withhold taxes from employees’ paychecks
At start of year, employers mail Form W-2 to employees
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29. Foundations of Personal Finance Ch. 7
Your Employer’s Role
Form W-4—taxes withheld depend on earnings and number of allowances claimed
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30. Foundations of Personal Finance Ch. 7
Your Employer’s Role
Form W-2—previous year’s pay and tax deductions are given

31. Preparing Your Return
Each year taxpayers must file a tax report with the government showing the taxes owed
Choose one of three common forms: 1040EZ, 1040A, or 1040

32. Choosing a Tax Form Use Form 1040, long form,
if income is over a certain amount
when adjustments to income, itemized tax deductions, and tax credits can reduce taxes
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33. Foundations of Personal Finance Ch. 7
Choosing a Tax Form
Use short forms, 1040A or 1040EZ, if
income falls into certain limits
deductions aren’t itemized

34. Figuring Taxable Income
Calculate gross income based on Forms W-2 and 1099s
Calculate adjusted gross income by subtracting adjustments from total income
Subtract allowable exemptions and deductions

35. Foundations of Personal Finance Ch. 7
Figuring Taxes Owed
IRS tax tables show taxes owed based on taxable income
Reduce the amount owed with tax credits

36. Filing on Time
Filing deadline for federal taxes and most state taxes is April 15
Tax avoidance—falsely reducing taxes
Tax evasion—failing to declare all income or falsifying documents

37. State and Local Tax Forms
Foundations of Personal Finance Ch. 7
State and Local Tax Forms
43 states collect income taxes
Taxpayers in states that collect personal income taxes must submit state tax forms

38. Electronic Filing Advantages of filing tax returns online:
It’s simple and quick
If refund is due, it arrives sooner
TeleFile allows taxpayers to file simple tax returns with touch-tone phones

39. Sources of Tax Information and Assistance
The IRS answers tax questions through free booklets, recorded messages, and a Web site
Tax preparation services fill out tax forms for a fee
Many taxpayers use tax preparation guides and software

40. IRS Audits A detailed examination of taxpayer’s tax returns by the IRS
During audit, taxpayers must answer IRS’s questions and provide documentation when asked
Taxpayers have legal protections in their dealings with the IRS

41. Foundations of Personal Finance Ch. 7
Tax System Reform
Legislators make laws that
raise or lower taxes
make the tax burden fairer
simplify the system
achieve other desired outcomes

42. Tax Legislation Many citizens are concerned about rising taxes
Questions asked when tax policy changes:
Will revenues generated by the new tax exceed administration costs?
Will it be fair to all taxpayers?
Will it impact the economy negatively?

43. Paying Social Security Taxes
FICA taxes calculated as a percentage of income; deducted from gross pay
Employers and workers split FICA taxes
Employees pay 6.2 percent for Social Security and 1.45 percent for Medicare
Employers contribute an additional 7.65 percent
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44. Paying Social Security Taxes
Foundations of Personal Finance Ch. 7
Paying Social Security Taxes
The self-employed pay all FICA taxes themselves
Federal government receives FICA contributions and credits them to employees’ accounts

45. Your Social Security Number
Social Security Administration uses SSNs to keep records of earnings; records determine benefit amounts
IRS uses SSN as taxpayer ID number
Each SSN is unique
Safeguard your SSN

46. Social Security Benefits
If you work, your Social Security taxes pay for benefits others receive
When you no longer work (retire, become disabled, or die), you and your dependents will get benefits provided by other workers’ Social Security taxes
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47. Social Security Benefits
Types of benefits:
Retirement
Disability
Survivors’
Benefits for divorced people

48. Social Security System Reform
Benefits paid out will soon exceed tax collection
Social Security fund will be depleted; no money to pay benefits of workers paying into the system now
Taxes may have to be raised, benefits decreased, or both

49. Central Ideas of the Chapter
Taxes reduce each individual’s income and wealth.
The taxes of many make it possible for government to provide public goods and services that benefit all.

50. Glossary of Key Terms
Back
bonus. Money added to an employee’s base pay. It is usually a reward for performance or a share of business profits.
commission. Income paid as a percentage of sales made by a salesperson.
compensation. Payment and benefits received for work.
disability. A limitation that affects a person’s ability to function in major life activities.

51. Glossary of Key Terms earned income. Income from employment.
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earned income. Income from employment.
employer-sponsored retirement savings plan. A tax-deferred investment program that helps employees save for retirement.
employee benefit. A form of nonmonetary compensation received in addition to a wage or salary.

52. Glossary of Key Terms
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entitlement. A government payment or benefit promised by law to eligible citizens, such as Social Security and Medicare benefits, unemployment benefits, veterans’ services, food stamps, and housing assistance.
exemption. A tax benefit that reduces the amount of income a person is taxed on.

53. Glossary of Key Terms
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FICA (Federal Insurance Contributions Act). The law that requires the collection of social security payroll taxes.
Form W-2. A Wage and Tax Statement that states the amount an employee was paid in the previous year. It also gives the amounts of income, Social Security, and Medicare taxes withheld from an employee’s income during the year.

54. Glossary of Key Terms
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Form W-4. The Employee’s Withholding Allowance Certificate that tells the employer how much tax to withhold from an employee’s paycheck.
gross income. A worker’s earnings before deductions.
interest. Payments from financial institutions, businesses, and government to use customers’ money.

55. Glossary of Key Terms
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Medicaid. A government program administered by the states that pays certain health care costs for eligible low-income individuals and families.
Medicare. A federal government program that helps pay the medical expenses of people 65 and older and others with certain disabilities.

56. Glossary of Key Terms
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minimum wage. The lowest hourly wage employers can pay most workers by law.
net income. Gross income (plus bonuses) minus payroll deductions.
payroll deduction. An amount subtracted from gross income.
piecework income. A wage that is based on a rate per unit or item completed.

57. Glossary of Key Terms
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salary. Payment for work that is expressed as an annual figure.
Social Security. The federal government’s program for providing income when earnings are reduced or stopped because of retirement, disability, or death.
tax credit. An amount that can be subtracted from the taxes a worker owes, if eligible.

58. Glossary of Key Terms
Back
tax deduction. An expense that can be subtracted from a worker’s taxable income.
tip. Money paid for service beyond what is required.
unearned income. Earnings from sources other than work.
wage. A payment in exchange for an employee’s labor or services. The payment, which is usually in money, is paid by the hour, day, or by the piece.