Unit 4: Taxes

1. Unit 4: Taxes 5.1 Taxes and Your Paycheck

2. 5.1 Key Terms (there are a lot) • Payroll Tax • Income Tax • Federal Insurance Contribution Act (FICA) • Withholding • Gross Income • Net Income • Form W-4 • Internal Revenue Service (IRS) • Allowance

3. Payroll Taxes • Payroll taxesare placed on income earned by individuals. Payroll taxes are paid by individual employees and their employers.

4. What is FICA? FICA Tax: Federal Insurance Contributions Act : The law that requires workers and their employers to contribute to Social Security and Medicare. • Social Security Tax: provides benefits for retired workers and their dependents as well as for the disabled and their dependents. (Also referred to as the FICA tax.) • Medicare Tax: used to provide medical benefits for certain individuals when they reach age 65. Workers, retired workers, and the spouses of workers and retired workers are eligible to receive Medicare benefits upon reaching age 65.

5. Income Taxes: A closer look • Income Taxes: are taxes you pay on most types of income you receive. • Income taxes are not a fixed percentage. • Income taxes vary depending upon each taxpayer’s financial and family situation. • You are responsible for calculating the amount of federal income tax you owe.

6. Federal Income Tax Brackets 2012 • Each tax rate applies to a range of income, which is called a tax bracket. Each tax rate applies to a specific range of taxable income, which is income after various deductions have been subtracted. • Single Filing Status • 10% on taxable income from $0 to $8,700, plus • 15% on taxable income over $8,700 to $35,350, plus • 25% on taxable income over $35,350 to $85,650, plus • 28% on taxable income over $85,650 to $178,650, plus • 33% on taxable income over $178,650 to $388,350, plus • 35% on taxable income over $388,350 • Married Filing Jointly or Qualifying Widow(er) Filing Status • 10% on taxable income from $0 to $17,400, plus • 15% on taxable income over $17,400 to $70,700, plus • 25% on taxable income over $70,700 to $142,700, plus • 28% on taxable income over $142,700 to $217,450, plus • 33% on taxable income over $217,450 to $388,350, plus • 35% on taxable income over $388,350.

7. What is a Withholding????????? Your employer collects taxes from each paycheck by deducting or withholding money from your wages. • Simply put withholding: employer deductions from employee’s earnings to pre-pay employee’s taxes.

8. Let’s put all this information into a real life example to make sense of it! • Kelly found a part-time job at a video store that pays $7.50 per hour. She wanted to take home at least $50.00 per week, so she agreed to work seven hours each Saturday. She expected her first paycheck to be $52.50. She was surprised to find it was only $40.39. • Why wasn’t Kelly’s paycheck what she expected? • Because of her payroll and income taxes

9. Kelly Example cont….. • What is Kelly’s gross income? • Yes, $52.50 (7 hours X $7.50 per hour) • Gross Income: the amount you earn before taxes are withheld. • What is Kelly’s net income? • Yes, $40.39 • Net Income: the amount you receive after withholdings are subtracted from your gross income. (also referred to as take-home pay)

10. Form W-4 • The amount of income tax you owe depends upon several factors: • Your gross income • The number of people you support • Other expenses you pay • When you are hired your employer will ask you to complete federal Form W-4, which is required by law.

11. What is an allowance? (not the one your parents give you for taking out the garbage) • An allowance is the number that reduces the amount of income withheld from your pay. • The more allowances you claim, the smaller the amount withheld will be & the higher your paycheck. • The fewer allowances you claim, the larger the amount withheld will be & the lower your paycheck. • VERY IMPORTANT TO UNDERSTAND: The number of allowances you claim will not change the amount of tax you owe. Your actual tax obligation is calculated on your tax return and then compared to your withholdings.

12. For example: • Suppose you claim five allowances on your W-4 when you should only claim one. Will the amount withheld by employers be larger or smaller ? • SMALLER • Based upon you W-4 your employer might withhold $500 from your pay over the year, but you may owe $3,000 in taxes. What happens? • You have to pay the rest of the taxes, $2,500 with your tax return.

13. Adjusting your allowance. • What if you are withholding too much: Refund by the IRS. • What if you are withholding too little: Send extra tax payments to the IRS Claim fewer allowances

14. Overwithholding as a way to save? • Is having more income than necessary withheld from your paycheck a good way to save? • From a financial standpoint NO. Why? • If you have more money withheld you are in essence letting the government use your money for free. You deposited the extra money from each paycheck you could be earning interest on it instead.

15. Payroll Taxes & Income Taxes Overview Important Basics to Remember: • Payroll & Income taxes are withheld from employees’ pay by their employers. • Employers send withheld taxes to the federal government. • Payroll taxes include Social Security (FICA) tax and Medicare tax. • The Social Security tax rate is 6.2%. • The Medicare tax rate is 1.45%. • Employees complete Form W-4 – claim allowances. • Employers use Form W-4 to compute the amount of income tax to withhold.