Paying Taxes Chapter 6

Learning Objectives Describe the basic principles of taxation and the major categories of taxes Explain payroll taxes Discuss the purpose and process of filing tax returns Understand how taxes affect your financial plan

Objective 1: Describe the basic principles of taxation and the major categories of taxes

Gross Pay vs. Net Pay Gross Pay Net Pay Total amount of money a worker earns in a pay period Hourly wages multiplied by the hours worked Or salary if you have it Total amount of money a worker takes home in a pay period aka take-home pay Money you get after paying taxes and other deductions

Purpose of Taxation (Four Rs) Revenue – MAIN PURPOSE – raise money the government uses for roads, schools, hospitals, etc. Redistribution – taking wealth from one part of society (the wealthy) and redistributing it to another part Repricing – taxes can sometimes be used to make items more expensive resulting in people not wanting to use that item (cigarettes) Representation – people expect government to serve their needs in return for their financial support

Tax Basics TAX is money collected by government from its citizens for the purpose of operating the government Income taxes Property taxes Gas, tobacco Businesses also pay taxes Government uses taxes to fund governmental services/programs National defense, fire and police, road construction/maintenance, public schools, Social Security, welfare are all paid for through TAX REVENUE

Tax Basics Sales Tax Real Estate Tax Payroll Tax Done when making a purchase at a store The merchant collects the money and then sends it to the government Done through STATE and not FEDERAL Calculated by the government based on the value of the property Primarily used to fund local schools They increase property taxes to provide better school facilities You pay every time you get paid Federal and state taxes withheld from a person’s paycheck and sent to the government by his/her employer FICA withheld as well 1. Social Security 2. Medicare

Pay Stub Shows: Employee’s gross pay for the period Amount withheld from employee’s gross pay for FICA and other payroll taxes Employee’s net earnings for the year

The Internal Revenue Service The IRS is the government body that enforces federal tax laws and collects taxes Branch of US Treasury Department Congress makes law, IRS enforces law

Tax Returns Each year you earn an income over a certain amount, you must file a federal tax return with the IRS Generally you use a form called 1040 or 1040EZ Purpose of a tax return – report to the IRS all the information relative to you income taxes How much you earned from all income sources How much you paid to IRS through withholding or estimated payments You must figure exactly what tax you should paid for the tax year If withholding > that number, you get a refund If withholding < that number, you owe money

Example 1040EZ form

Filing Your Taxes Taxes are based on earnings for that calendar year (January – December) You have until APRIL 15TH to file your tax return

Objective 2: Explain payroll taxes

Payroll Taxes Personal payroll taxes (Federal and State) Also includes Social Security and Medicare (aka FICA – Federal Insurance Contribution Act) In some cases, FICA (Medicare and social security) is known as OASDI (Old- Age, Survivors, and Disability Insurance) Employers match employee’s contribution to FICA and sends that amount to the government

Social Security and Medicare Provides payment to eligible retirees and disabled people Typically equal to 4.20% of your salary Provides health care coverage to most older Americans and some younger disabled people Health insurance provided by government for those 65+

Personal Income Taxes Taxes imposed on the income you earn The more money you earn, the higher the rate at which you pay taxes You pay federal AND state (TEXAS does NOT have a state personal income tax)

Discuss the purpose and process of filing tax returns Objective 3: Discuss the purpose and process of filing tax returns

Filing Status You must specify a filing status when you submit you income tax return – applicable tax rates and rules will differ depending on which you choose Single Married filing jointly Married filing separately Head of household – single person who has a child Qualifying widow(er) with dependent child You’re considered a dependent until 18 (means you are financially dependent upon someone else) which lowers what your parent/guardian owes in taxes You still have to file a tax return

Gross Income/Total Income The first step in calculating the federal tax you owe is determining your GROSS INCOME Consists of the total amount of a person's income from any source At the end of the year your employer will send you a document called a W-2 that summarizes all of your relevant income and tax withholding information from each employer you had Capital gains – a taxable gain that occurs when you sell an asset for more than you paid for it (example: stocks) Gross income also includes income from tips, rental properties, business income, game show winnings, scholarship amounts NOT a part of gross income: insurance reimbursements, child support payments, moving expenses, veteran’s and welfare benefits

Adjusted Gross Income - AGI Game Show Winnings Income calculated by taking total income and subtracting allowable amounts (contributions to certain retirement accounts, alimony payments, interest paid on student loans, and other expenditures that are identified by the IRS) Considered income You must pay taxes on them Use form 1099-MISC Rule of thumb: you’ll have to pay 50% of what you earn in taxes

Deductions and Exemptions Standard Deduction Itemized Deduction Fixed amount ALL TAXPAYERS are allowed to deduct from their AGI to reduce their tax liability Varies according to your filing status and whether you’re over the age of 65 Specific expenses that can be deducted from income to reduce the amount of income subject to income tax Interest paid on mortgage Real estate taxes Charitable donations Large medical expenses

Refund or Payment? Accurate completion of your tax return will show you whether you need to pay additional income taxes that year If you overpaid you get a refund In some cases, low income families will receive more money back in the form of an Earned Income Credit than was withheld from their paychecks In most cases, you will not receive an income tax return refund unless you pay taxes during that year

Objective 4: Goal: Take steps to lower their tax liability (what they owe) to the lowest possible level for their income You get to keep more of your own money rather than pay it to the government in taxes Understand how taxes affect your financial plan