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Understand tax fundamentals, types, IRS functions, income tax workings, returns preparation, deductions, and dependents to optimize your tax strategy. Learn about income and adjusted gross income, payroll withholding, and how to complete a W-4 form effectively.
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Chapter 12Planning your tax strategy Section 12.1 Income Tax Fundamentals
An everyday expense that allow your local, state, and federal governments to provide important services. Medicare Medicaid The Military The national debt Police Fire department Schools Roads Parks Libraries What are Taxes
Strategies to plan for taxes • Find out current tax laws and regulations that affect you • Maintain complete and accurate tax records • Make decisions that reduce your tax liability • (What is tax liability?)
Types of Taxes • Tax on Purchases – sales tax • Tax on Property – based on the value of land and buildings • Tax on Wealth – Estate and Inheritance tax • Tax on Earnings – income tax, tax on wages
IRS – Internal Revenue Service • The federal agency that collects these taxes • 2 primary jobs of the IRS • Collect federal income tax • Enforce the nation’s tax laws
How does income tax work? • Your employer must withhold, or take out, Social Security tax and income tax payments from your paycheck and send them to the IRS. • If you are self employees, own your own business, or are retired you could be required to make your own estimate payments. • If you have paid too much or too little through out the year, when you do your yearly income taxes you either get a refund or pay more.
Preparing Tax Returns • An income tax return can be a form such as a 1040A or a 1040EZ, which reports how much money he or she received from working and taxes you are owed. • Refund = If the income tax you paid through the year was greater that your liability • Pay = If your liability is greater than the tax your paid, you have to pay the difference
Gross and Adjusted Gross Income • Earned Income – the money you receive for working, including wages, salary, commissions, fees, tips, bonuses, and self employed earnings. • Interest Income – the interest that you receive from banks, credit unions, and savings and loans • Dividend income – the cash dividends that you receive from investments • (What is an exclusion?)
Adjusted Gross Income • Your gross income after calculating certain reductions. These reductions are called adjustments. (IRA or Student loan interest contributions) • The correct amount of you adjusted gross income is important because it is the basis for other tax calculations. • If you have adjustments you cannot use the 1040EZ form)
Deductions • Expenses you can subtract from your adjusted gross income to figure your taxable income • Standard – amount of money set by the IRS that is not taxed • Itemized – specific expenses that you can deduct from your adjusted gross income
Common Itemized Deductions • Medical Expenses • Dental Expenses • Taxes (state and local income taxes, personal property taxes) • Interest (mortgage) • Contributions (Charitable)
Dependents • To qualify as a dependent • A dependent must not earn more than a set amount unless her or she is under the age of 9 or is a full time student under the age of 24 • A dependent must be a specified relative or live in the home of the taxpayer who claims him or her on the tax return • More than half of a dependent’s support must be provided by the taxpayer who claims him or her on the tax return • A dependent must me certain citizenship requirements
Payroll Withholding • When you start a new job you are going to be asked to fill out a W-4, called an Employee’s Withholding Allowance Certificate • This tells your employer how much to deduct and send to the IRS
Completing a W-4 • Fill out your name and address • Fill in your social security # • Indicate whether you are single or married • Check the box if your last name is different from the name shown on your social security card • Write the number of allowances you are claiming. (To figure this out complete the personal allowances worksheet at the top of the W-4)
Completing W-4 continued: • Indicate how much additional money, if any you would like withheld • If you meet the conditions listed on the form and indicate that you are exempt, or excused, from paying income tax, no income tax will be withheld • Sign and date the form
Claiming Allowances • Some employees claim few allowances on their W-4 so that more tax money is withheld. • This way you can possibly receive a larger refund • The downside to this is the government does not have to return that extra money until your taxes are filed.
