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Copyright © 2011 Pearson Education, Inc. Slide 4-3 Unit 4E Income Taxes

4-E Copyright © 2011 Pearson Education, Inc. Slide 4-4 Income Tax Preparation Flow Chart

4-E Copyright © 2011 Pearson Education, Inc. Slide 4-5 Filing Status 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 Tax calculations depend on your filing status, which consist of the following four categories:

4-E Copyright © 2011 Pearson Education, Inc. Slide 4-6 Exemptions and Deductions 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. Both exemptions and deductions are subtracted from your adjusted gross income.

4-E Copyright © 2011 Pearson Education, Inc. Slide 4-7 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).

4-E Copyright © 2011 Pearson Education, Inc. Slide 4-8 2006 Marginal Tax Rates, Standard Deductions, and Exemptions

4-E Copyright © 2011 Pearson Education, Inc. Slide 4-9 Tax Credits and 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. As a rule, tax credits are more valuable than tax deductions.

4-E Copyright © 2011 Pearson Education, Inc. Slide 4-10 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 Credits vs. Tax Deductions Tax credit – \$1000 is deducted from your tax bill \$1000 is saved Tax deduction – taxable income reduced by \$1000 is saved

4-E Copyright © 2011 Pearson Education, Inc. Slide 4-11 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 Some income is subject to Social Security and Medicare taxes, which are collected under the name FICA (Federal Insurance Contribution Act) taxes. Social Security and Medicare Taxes

4-E Copyright © 2011 Pearson Education, Inc. Slide 4-12 Dividends and Capital Gains 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 Income with special tax treatment:

4-E Copyright © 2011 Pearson Education, Inc. Slide 4-13 Tax-Deferred Income Individual retirement accounts (IRAs) Qualified retirement plans (QRPs) 401(k) plans Tax-deferred savings plans allow you to defer income taxes on contributions to certain types of savings plans. These include the following: