Federal Income Tax

1. 7 Federal Income Tax 7.1 Our Tax System 7.2 Filing Tax Returns

2. Lesson 7.1Our Tax System GOALS • Explain the purpose of taxes and describe the different types of taxes. • Describe the U.S. tax system and explain how it works. Chapter 7

3. Purpose of Taxes • In a free enterprise system such as ours, the government collects money from citizens and businesses in the form of taxes. • These incoming funds to the government are called revenue. • The government spends the revenues received according to priorities set by Congress. Chapter 7

4. Types of Taxes • Progressive taxes • Regressive taxes • Proportional taxes Chapter 7

5. Progressive Taxes • Progressive taxes take a larger share of income as the amount of income grows. • Federal income taxes are progressive. Chapter 7

6. Regressive Taxes • Regressive taxes take a smaller share of income as the amount of income grows. • Sales taxes are regressive. Chapter 7

7. Proportional Taxes • Proportional taxes, or flat taxes, are taxes for which the rate stays the same, regardless of income. • Property taxes are proportional. Chapter 7

8. Components of the Tax System • The IRS • The power to tax • Paying your fair share • Tax rates apply to income ranges, or tax brackets. • Our income tax system is based on voluntary compliance, which means that all citizens are expected to prepare and file tax returns of their own accord without force. Chapter 7

9. (continued) Components of the Tax System • Failure to pay taxes • Failure to do so can result in a penalty: interest charges on the taxes owed plus a possible fine. • Willful failure to pay taxes is called tax evasion, which is a serious crime punishable by a fine, imprisonment, or both. Chapter 7

10. An IRS Audit • Every year, the IRS calls millions of taxpayers for an audit, which is an examination of their tax returns. • Types of audits • Office audit • Correspondence audit • Field audit Chapter 7

11. Lesson 7.2Filing Tax Returns GOALS • Define basic tax terminology. • Prepare tax forms 1040EZ and 1040A. Chapter 7

12. Filing Status • Filing status describes your tax-filing group. • You must mark one of the following as your filing status on your tax form: • Single person (not married) • Married person filing a joint return • Married person filing a separate return • “Head of household” • Qualifying widow(er) Chapter 7

13. Exemptions • An exemption is an amount you may subtract from your income for each person who depends on your income to live. • Each exemption reduces your taxable income and thus your total tax. Chapter 7

14. Exemptions—Who Qualifies • Yourself, unless someone else claims you on their return • Your spouse, if you are filing jointly • Your dependents • A dependent is a person who lives with you and for whom you pay more than half his or her living expenses. Chapter 7

15. Gross Income • Gross income is all the taxable income you receive. • Earned income refers to money you earned from working. • Unearned income refers to money you received from passive activity (other than working). Chapter 7

16. Common Types of Income • Wages, salaries, and tips • Interest income • Dividend income • Unemployment compensation • Social security benefits • Child support • Alimony Chapter 7

17. Adjusted Gross Income • The law allows you to subtract some types of spending from gross income. • You can “adjust” your income by subtracting such things as contributions to individual retirement accounts, student loan interest, and tuition and fees. • These adjustments are subtracted from gross income to determine adjusted gross income. • Adjustments reduce income that is subject to tax. • Note that these adjustments are not available on Form 1040EZ. Chapter 7

18. Adjusted Gross Income Gross income – Adjustments Adjusted gross income Chapter 7

19. Taxable Income • Taxable income is the income on which you will pay tax. Chapter 7

20. Gross income – Adjustments Adjusted gross income (continued) Taxable Income – Deductions – Exemptions Taxable income Chapter 7

21. Deductions • Itemize deductions • Standard deduction Chapter 7

22. Itemize Deductions • Itemize deductions are expenses you can subtract from adjusted gross income to determine your taxable income. • Examples include: • Medical and dental expenses beyond a specified percentage of your income • State and local income taxes • Property taxes • Home mortgage interest • Gifts to charity • Losses from theft or property damage • Moving expenses Chapter 7

23. Standard Deduction • If you do not have many deductions, your tax may be less if you take the standard deduction. • The standard deduction is a stated amount that you may subtract from adjusted gross income instead of itemizing your deductions. • This amount changes each year. Chapter 7

24. Tax Credits • A tax credit is an amount subtracted directly from the tax owed. • It is different from a deduction. • A deduction is subtracted from adjusted gross income. • It reduces your tax by reducing the amount of income on which the tax is figured. • A tax credit reduces the tax itself. • The government allows tax credits for certain education expenses, child-care expenses, and other reasons from time to time. Chapter 7

25. Preparing Your Income Tax Return • Who must file? • When to file? • Which form to use? • Where to begin? • Filing electronically • Tax preparation software Chapter 7

26. Form 1040EZ • Step 1: Name, address, and Social Security number • Step 2: Report income • Step 3: Compute tax • Step 4: Refund or amount owed • Step 5: Sign the return Chapter 7

27. Form 1040A • Step 1: Name and address • Step 2: Filing status • Step 3: Exemptions • Step 4: Income • Step 5: Adjusted gross income • Step 6: Taxable income • Step 7: Tax, credits, and payments • Step 8: Refund or amount owed • Step 9: Signature Chapter 7