Income and Taxes

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. continued

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. Money Earned from Work • Income received from employment is earned income continued

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 ofemployee 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. Payroll Deductions • Net income (take-home pay) is gross income minus payroll deductions continued

11. Payroll Deductions • Deduction can lower a paycheck by 20 percent or more • Bonuses increase gross income continued

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 • 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 continued

16. 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 continued

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 • 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 continued

22. 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 continued

24. 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 continued

26. What Is Taxed? • Property tax—real estate property tax and personal property tax • Wealth tax—assets (estate and gift taxes)

27. 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 continued

29. Your Employer’s Role • Form W-4—taxes withheld depend on earnings and number of allowances claimed continued

30. 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 continued

33. 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. 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 • 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. 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 continued

44. 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 continued

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.