Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes
Read foreword on pg. 150
Objective #1 – Understand the purpose of taxes, different types of taxes, and the history of taxes in the US. Pgs. 151-153
What are taxes? Revenue collected by our government. In the free enterprise (capitalist) system found the in the US money is collected by the gov’t from citizens and businesses. This revenue is redistributed according to the needs and priorities of Congress. Largest Source of Government Revenue: Income Taxes
Other taxes collected that provide our government with revenue are social security taxes, excise taxes, import duties, and personal property taxes.
How does our government decide how much people should pay? Ability-to-Pay Principle – theory that states that people with make more money (wealthier) should pay more taxes.
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Types of Taxes: 1. Progressive Taxes – those that increase in proportion to income. People who make more money pays taxes because their rate (bracket) changes. 2. Regressive Taxes – those that decrease in proportion to income. The person with the higher income pays a lower percentage of income than a lower income person. Sales Tax. Poor are taxed at a higher rate in proportion to their income. a. A.K.A – “Pay-as-you-Go” Taxes. b. Excise Taxes – another form of regressive tax. An excise tax is one that is imposed on specific goods and services such as gas, cigarettes, alcoholic beverages, air travel, and telephone services. 3. Proportional Taxes – flat taxes are those for which the rate remains constant even though the amount being taxed increases. I.e. Property taxes. Money is paid to local tax assessor book says monthly or semiannually – its QUARTERLY around here. Local taxes provide for education, parks & recreation, streets & roads, as well as police, fire, and health departments.
History of Taxes: For many years the US operated without income tax. People immigrated to US to avoid British taxes because at that time we were still a colony of England. The Revolutionary War brought independence and t here was still no direct income tax imposed on citizens. In 1787, Constitution mentioned taxes, but was optional. Excise taxes and customs duties provided enough revenue to US at that time. Government did not provide services to citizens at this time, however. The Revolutionary War was financed by sympathetic France. The War of 1812 brought a temporary tax, but was dropped after the war. The Civil War was an economic burden and INCOME TAX was levied to finance the war.
2 Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes In 1862, President Lincoln signed a bill into law that provided a progressive income tax on wages earned. The tax expired when the war debts were paid off. In 1909, Congress introduced the first permanent income tax by making it the 16th Amendment to the Constitution. 16th amendment was ratified by ¾ of states in 1913. Nominal taxes were levied. WWI, 1917, was paid for by income taxes. After WWI, the Great Depression happened and many people suffered badly. President Franklin D. Roosevelt introduced the “New Deal” which brought prosperity though taxation and the “redistribution of wealth.” 1935 – Social Security Act was signed into law, creating the IRS (Internal Revenue Service). IRS – collected taxes and turned them over for the payment of gov’t debt, commitments, and benefits. Social Security withholdings was deposited in the US Dept. of Treasury. WWII – taxes were increased to finance war. This set a precedent for the changing tax rates we know today. These taxes pay for the services and needs of our government and society.
Objective #2 – Describe the components of the tax system, including the IRS, the power to tax, and paying your fair share. Pgs 153-155
Components of the Tax System: 1. IRS – Gov’ts power to tax income 2. Each taxpayer’s willingness to pay his or her fair share.
IRS: Agency of the US Dept. of Treasury Headquarters – Washington, DC 7 Regional Offices throughout country. Each regional office oversees at least 10 district & local offices. Mission: collect income taxes & enforce tax laws Local offices assist taxpayers in finding info. & forms.
3 Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes Prints brochures & pamphlets free to help tax payers.
The Power to Tax: The power to levy taxes rests with Congress (which is made up of the House of Representatives and the Senate). As directed by the Constitution, the House of Representatives provides that “all bills for raising revenue shall originate in the House of Representatives.” President, Dept. of Treasury, or Congressperson may propose to increase or decrease taxes. The House Ways and Means Committee studies the proposals and makes recommendations to the full House. Revenue bills must pass a vote in both the House and the Senate & be signed by the president before becoming law.
Paying Your Fair Share: Income Tax is Graduated – the more income you make, the more you pay. Tax rates change as Congress seeks ways to bring in more money in order to balance the budget and reduce deficit. A deficit is the result of Congress spending more money than it has received. The three tax brackets used to be 15%, 28%, and 31%. President Clinton added another bracket – 36% for couples earning over $140,000 or individuals earning over $100,000 (high-income taxpayers). This additional revenue was used to reduce the national debt. Voluntary Compliance – All citizens are expected to prepare or have prepared and file income tax returns. April 15th is the yearly deadline. Responsibility lies with the individual. Failure can result in penalties, interest charges on the taxes owed, a fine, and possibly imprisonment. Tax Evasion – willful failure to pay taxes. Is a felony and punishable by fine, imprisonment or both.
4 Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes
What do YOU do if the IRS audits you? 1. You can represent yourself all the way to an appeal in Tax Court. 2. Give someone Power of Attorney (lawyer, member of the immediate family, or an enrolled agent of the IRS). 3. Bring tax preparer or therapist or along for support during the session. 4. (Most audit session involve confirming supportive documentation and most taxpayers go alone unless problem is serious/complicated.) 5. There are correspondence audits, office audits, and field audits. The office audit involves taxpayer sitting with IRS and answering questions and producing records. A field audit is where the IRS agent visits one’s home.
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Objective #3 – Define and show a working knowledge of exemptions, dependents, and taxable and nontaxable income when preparing tax returns. Pgs. 155-164
Definition of Terms:
1. Filing Status (5 ways to file a tax return) a. Single (not married) b. Married person filing a joint return (even though 1 spouse may have earned income). c. Married person filing a separate return d. “Head of Household” – a person may qualify as a head of household whether married or single if certain conditions are met in providing a residence for persons dependent on the taxpayer. e. Qualifying Widow(er) with a dependent child.
2. Exemptions – an allowance a taxpayer claims for each person dependent on the taxpayer’s income. You are automatically allowed one exemption for yourself unless someone else (parent) claims you on his or her return. You cannot claim a former spouse. 3. Dependent – a person who lives with you and who receives more than half his or her living expenses from you. Dependents decrease your gross income ($2350 in 1994 – cost of living increases apply each year, however). The be a dependent you must meet the following 5 requirements: a. Person must be a relative (child, stepchild, adopted child, foster child, grandchild, great grandchild, son-in-law & daughter-in-law, grand or great grandparents; brother, sister, step brother, brother-in-law or sister-in-law; or any relation by blood (aunt, uncle, nephew, niece). b. Must be a citizen or resident of US, or resident of Canada or Mexico. Or, an adopted child who is not a US citizen but has lived with you all year in a foreign country. c. If the person is married, he or she cannot file a joint return with his or her spouse.
6 Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes Dependent Requirements continued:
d. The person’s income must be less than the amount of her or his exemption ($2450 when book was written). Does not apply to children under age of 19 or to a student under age of 24.\ e. You must provide over half of the person’s support during the year. ALSO – children of divorced parents: the parent who has custody of a child for most of the year can claim as dependent on their tax form. Exceptions are: 1. Custodial parent agrees not to claim the exemption, 2. if the divorce decree entered into before 1985 allows the noncustodial parent to claim the exemption and the noncustodial parent contributed at least $600 for the child’s support during the year, or 3. If the divorce decree grants the exemption to the noncustodial parent.
4. Gross Income – all the taxable income you receive, includes the following: a. Wages, Tips, Salaries b. Interest – bank interest, savings & loan associations, credit unions, Series HH Savings Bonds interest. You will receive a 1099-INT from institution. c. Dividends from stock. You will receive FORM 1099-DIV. d. Unemployment Compensation – Form 1099-G, amount is entered on tax form as income. e. Alimony – money paid to former spouse. Is taxable for person receiving it and a deductible for person paying it. Taxpayer must fill out Form 1040. f. Workers’ Compensation Benefits g. Scholarships and Grants are taxable if they are NOT used for tuition and books. For non-degree candidates, more may be taxable. Employer reimbursed tuition is taxable. h. Types of income that are NOT reported as income are: child support, gifts, inheritances, life insurance benefits, and veteran’s benefits. i. Social Security Benefits – 85% of benefits are taxable if total income exceeds $34,000 (single) and $44,000 (married). Form SSA-1099 lists SS benefits. j. Railroad Retirement benefits – Form RRB-1099.
7 Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes k. Child Support – (money paid to former spouse for dependent children) – income is NOT taxable for person receiving nor is it a DEDUCTIBLE for person paying it. l. Winnings from gambling, bartering income, pensions and annuities, rental income, royalties, estate & trust income, and income on sale of a property.
5. Adjusted Gross Income – you may make adjustments or subtract certain items directly from gross income including: a. IRA contributions (may not use 1040EZ) b. Adjusted Gross Income is the basis for computing other deductions.
6. Taxable Income: a. Deductions – are expenses the law allows the taxpayer to subtract from adjusted gross income. i. Itemized deductions – a list of certain expenses that all taxpayers are allowed to deduct. To itemize deductions, you must use a 1040A. 1. On the 1040A you may list medical & dental expenses if the amount exceeds 7.5% of adjusted gross income. 2. State & Local Income Taxes as well as Property Taxes 3. Home Mortgage Interest 4. Gifts to Charity 5. Qualifying Casualty and Theft Losses 6. Moving Expenses 7. Qualifying Job & Misc. Expenses ii. Standard Deduction – you may use instead of itemizing your deductions. See Figure 7-1 on pg. 160. Many people prefer using the standard deduction instead of itemizing (quicker and easier). Standard Deduction amount depends on your filing status (Fig. 7-1, pg. 160) 1. Standard deduction is higher for people 65+ and for blind people. 2. Once you subtract your standard deductions, you need to subtract your exemptions.
8 Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes iii.Taxable Income is (see Fig. 7-2, pg. 161):
Gross Income -Adjustments ADJUSTED GROSS INCOME -Standard Deduction or Itemized Deductions -Exemptions (allowances for each person dependent on you) TAXABLE INCOME
Preparing to File, pg. 161:
1. Gather INCOME & EXPENSE records. 2. Study TAX BOOKLET (laws and numbers change every year) 3. Read your return carefully to be sure you are taking advantage of EVERY possible deduction & reporting ALL taxable income. 4. Prepare your 1040EZ (15 minutes) 5. 1040A takes longer due to ITEMIZED DEDUCTIONS and gathering all pertinent information. 6. You will also have to prepare a state income tax return.
WHO Must File?
1. See Figure 7-3, pg. 162. 2. Persons claimed as dependents on another person’s tax return may have to file a special tax return. 3. If you owe any special social security taxes on tips. 4. If you earned $400+ from self-employment. 5. If you earned $100+ from a church or church-controlled organization that is exempt from employer social security taxes. 6. Persons who did NOT earn enough to owe taxes, but who had taxes WITHHELD from their paychecks, should file a return to reclaim monies withheld. 7. IF you do NOT file, you will not get a refund.
When to File? 1. April 15 of year after you earned the income. 2. If April 15 falls on a weekend or holiday, you return is due on the next regular weekday. 3. Late filers – subject to penalties and interest charges.
9 Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes Short Form or Long Form (See Fig. 7-4, pg. 164)? Short Form – 1040A (19%) or 1040EZ (17%) Long Form – 1040 (64%) Which form you use depends on type and amount of income, number of deductions, and other factors not mentioned in this text book.
Where to Begin? 1. Save all receipts during year for itemized deductions. 2. Save all employee withholding records. 3. January 31 – will receive your Form W-2 & 1099’s which show other income earned, Wage and Tax Statement from all employers. Compare with your records and check for accuracy. Social Security tax withholding rates increase periodically. 4. Prepare taxes early especially if getting refund. Our gov’t will be receiving interest on your money, not you. 5. If you owe money – send taxes and check postmarked by April 15. 6. You can prepare both forms (short and long) and compare to see if it you can save money by itemizing your deductions. 7. READ ALL DIRECTIONS CAREFULLY. 8. If you have to pay taxes, you may want to increase your withholding the following year. 9. If you receive a large refund, you may want to reduce allowance status. 10.You are responsible for supplying accurate and complete information even if you hire a tax preparer. 11.Save copies of your tax returns for 6 years.
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Objective #4 – Prepare Forms 1040EZ and 1040A (Individual Federal Income Tax Returns). Pgs. 165-175
Preparing Income Tax Returns (pg. 165): 1. Federal income tax return must be completed in ink or typed with no errors or omissions. 2. IRS provides booklets if you need additional assistance. 3. May hire tax preparer who may complete tax forms manually or by using TURBO TAX or another tax software. 4. ***SIGN YOUR TAX RETURN***
Form 1040EZ – Must be SINGLE or MARRIED and claim NO dependents. Taxable income – less than $50,000
Step 1: Name & Address Social Security number, check “Yes” if you want $3 to go to Presidential Election Campaign Fund. This fund was established by Congress so that all taxpayers could share equally in the costs of election campaigns.
Step 2: Reporting Income 1. Enter your total wages, salaries, and tips (found on W-2 form) 2. Enter interest earned on savings account (cannot be over $400). Add #1 & #2 together = ADJUSTED GROSS INCOME Indicate whether you are claimed as a DEPENDENT on another person’s tax return. (If yes, you will lose most of your standard deduction.) If no, enter standard deduction and of $6250, which is allowed on the 1040EZ. Subtract deduction amount from ADJUSTED GROSS INCOME to obtain your TAXABLE INCOME. Step 3: Compute Tax Enter Federal Tax Withheld (found on W-2 Form) Look up the amount of your taxable income and the amount of tax you owe in the tax tables. (See Appendix A for the EZ Tax Table, pg. 754-758.
11 Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes Step 4: Refund or Amount Owed If the amount of federal taxes withheld is larger than the amount of tax you owe, you will receive a refund. If you owe more tax than was withheld, you pay the difference. Write a check to IRS and attach to your return.
Step 5: Sign the Return Sign your tax return. Attach W-2 forms and check if you owe money. Mail completed form to the regional IRS office in your area.
12 Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes Preparing Form 1040A: 1040A is 4 pages. Instructions are available in the booklet “Instructions for Preparing 2004 1040EZ and 1040A. This form is used for individuals who have less than $50,000 in taxable income from wages, salaries, tips, unemployment compensation, interest, or dividends. Form 1040A – can take deductions for IRA contributions Form 1040A – can take deduction for child care expenses.
Step 1: Name & Address: Write in your name, address, social security number, and occupation of persons filing the return. If you have paid taxes previously, IRS will send you a preprinted label with the above information in January. Affix this to your return. Check whether or not you would like to give to the Presidential Election Campaign Fund.
Step 2: Filing Status Fill in spouse’s name and social security number if filing separately, names of dependents if you are head of household, and year spouse died, if filing as widow(er).
Step 3: Exemptions Form 1040A provides space for this. Claim yourself & spouse if filing jointly, enter the names of dependents as well as QUALIFYING INFORMATION.
Step 4: Total Income Enter wages, salaries, tips, and of income as shown on W-2. Report all taxable interest. If you received over $400 in interest, list the name of each payer and the amount on Schedule 1 (see Fig. 7-9 on page 174). List tax-exempt interest income, even if not taxed. Enter income from dividends. (If you have over $400 in dividends, it must be listed separately on Schedule 1, pg. 174) Enter taxable amount of any money received from IRA’s, pensions, and social security benefits. Enter unemployment compensation income. Attach From 1099G.
13 Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes Preparing Form 1040A (cont.):
Step 5: Adjusted Gross Income Deduct contributions to IRA (employee who earns at least $2000 can contribute up to $2000 toward IRA, if they qualify – see Publication 17). IF both taxpayers are eligible, IRA deductions are entered and totaled. Subtract total from GROSS INCOME. Difference = ADJUSTED GROSS INCOME.
Step 6: Taxable Income Enter Adjusted Gross Income Check to see if spouse is 65, older, or blind, claimed as dependent by other taxpayer, or if you are married filing separately. Standard deduction (when this book was written): o $3800 for Single o $6350 for Married Filing Jointly or Widow(er) o $3175 for Married Filing Separately o $5600 for Head of Household Subtract STANDARD DEDUCTION amount from ADJUSTED GROSS INCOME. Subtract number of exemptions multiplied by $2450 (the amount allowed for each exemption when this book was written) from ADJUSTED GROSS INCOME. This is TAXABLE INCOME.
Step 7: Figuring Taxes, Credits, and Payments (This section is used for entering the amount of tax liability, based on your taxable income, and credits due to you.) Find amount of tax due using tax tables in Appendix B on pg. 759- 765. Claim any credit due for child care expenses. Complete Schedule 2, Part 1 to determine amount of the credit. Subtract from the tax liability. After credits are subtracted – this is your total tax liability. Enter Federal Income Tax Withheld, found on W-2 Form. Enter Earned Income Credit (EIC) if taxes were withheld. (I.e. When this book was written, people who have a child, but income of less than $25,296 the EIC could be as much as $2528.
14 Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes Add taxes withheld + EIC
Step 8: Refund or Amount Owed If the amount withheld + credits exceeds liability, the difference is your REFUND. If you have more tax liability than the amount withheld or computed as a credit, you OWE taxes. IF you owe, attach check to tax return.
Step 9: Signature Tax payer and spouse must sign & date joint return even if only one may have earned the income.
See Figure 7-5, John Calhoun’s Form W-2, Wage & Tax Statement. See Figure 7-6, pg. 170 – completed Form 1040EZ
Mr. Calhoun: 1. Single 2. Claims 1 exemption 3. Wages – on W-2 Form 4. Earned $134 interest on savings account. 5. No one else can claim him as a dependent. 6. Appendix A - Mr. Calhoun locates TAX LIABILITY of $1294 7. When tax liability of $1294 - $1501 (taxes withheld) = $207 8. Refund amount: $207
Michael J. & Melissa B. Anderson: 1. See Figures 7-7a & 7-7B on pg. 171 for Wage & Tax Stmts. For Michael J. & Melissa B. Anderson. 2. Figures 7-8A & 7-8B, pg. 172-183 show their JOINT RETURN (1040A).
Preparing tax returns is important and mandatory; willful failure to do so is a FEDERAL OFFENSE.
Assessments: Vocabulary – pg. 176 Worksheets Test
15 Personal Financial Management Mrs. Shill Chapter 7 – Federal Income Tax Class Notes Life Situation Problem Solving– pg. 178, Problem #1 & #2; use Turbo Tax
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