Tax Preparation

Federal Income Tax Structure  Federal and State income taxes are progressive tax  The higher your income, the greater percentage is paid in taxes  See Tax Freedom Day (Table 4.1)  Almost four months of your yearly income goes to pay various taxes

Tax Vocabulary  Tax Brackets:  Income ranges in which the same tax rates apply  For example: 15%, 25%, 35%, etc.

Exemptions  A reduction in you taxes because you are human  $3650 per person in 2009  Personal  Take this for yourself and 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 studentsThe 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  You must provide more than half of dependent’s support

Tax Vocabulary, continued  Deductions:  Expenses that reduce taxable income  You can either take the Standard Deduction or Itemize your deductions

Standard Deduction  The standard deduction is the government’s best estimate on what the average person would be able to deduct by itemizing  The standard deduction for 2009 is $11,400 for married individuals and $5,700 for single individuals

Itemizing Deductions  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

Tax Vocabulary, continued  Taxable Income:  Income subject to taxes after deductions and exemptions are subtracted

Tax Example  $70,000 gross income, married with three children  Subtract exemptions (five X $3,650 = $18,250)  Subtract deductions, either itemized or standard ($11,400)  Taxable income = $70,000-$18,250- $11,400=$40,350

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 15%  Average tax rates are your actual taxes divided by your taxable income:  $6,087.50/$45,250 = 13.45%  Or by your total income:  $6,087.50/$70,000 = 8.7%

Filing Status  Single:  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 child living with you  Qualifying Widow(er) With Dependent Child  Use this for up to 2 years following the death

Who Has To File A Return?  If your unearned income is greater than $2350  If your earned income is greater than $7100

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

Calculating Your Base Income Tax  For most taxpayers, this is calculated using tax  Once taxes have been calculated, credits can be deducted

Income Tax Credits  Child credit (this can become a refund for parents who don’t pay taxes)  Hope Scholarship Tax Credit  Credit for tuition, up to $2000 for two years  Child and dependent care credit  Credit for money paid for child care  Earned income credit  For low-income families, may result in negative taxes paid

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

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

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