Chapter 7
Federal Income Tax
"In this world nothing is certain
but death and taxes.“
- Benjamin Franklin
Lesson 7.1
Our Tax System
GOALS
Discuss the purpose of taxes, different
types of taxes, and the history of taxes
in the United States.
Describe components of the tax system,
including the IRS, the power to tax, and
paying your fair share.
Types of Taxes
Revenue
Taxes (money) collected from citizens
and businesses
Largest source is income taxes
Other sources include social security,
unemployment insurance, inheritance,
estate and property taxes, and import
duties.
Types of Taxes
“Ability-to-Pay Principle”
Theory that people with higher
incomes should pay more, lower
incomes pay less
Progressive taxes
Federal income taxes
More you make, the higher percentage
of income you pay in taxes
Types of Taxes
Regressive taxes
Sales tax
Fixed percentage, so the smaller your
income the greater percentage of your
income it taxes to pay
Types of Taxes
Example of Regressive Tax
Low income ($10,000 per year)
Buy stereo for $2000
Pay $2000(.06) = $120 in sales tax
$120/$10,000 = .012 or 1.2% of income
High income ($80,000 per year)
Still pay $120 in sales tax for stereo
$120/$80,000 = .0015 or 0.15% of income
Types of Taxes
Proportional taxes
Also called “flat taxes”
Tax rate stays the same regardless of
the amount
Property taxes are a good example
Percentage is the same if home is
$150,000 or $1.5 million
Components of the Tax
System
The IRS
Internal Revenue Service
Headquarters in Washington, DC
7 regional offices
Established to collect taxes and
enforce tax laws
www.irs.gov
Components of the Tax
System
The power to tax
Congress has power to levy
Proposals to increase may come
from President, Dept. of Treasury
or Congressmen
Components of the Tax
System
Paying your fair share
Tax brackets
Tax ranges that increase as income
increases
Taxes increase when government needs
more money to balance budget
All citizens are expected to prepare
and file tax returns (voluntary
compliance)
Components of the Tax
System
Tax evasion
“Willful failure to pay taxes”
Audit
IRS examines your tax returns
Up to 7 years prior
History of Taxes
Revolutionary War
No direct income tax
Constitution stated “option to tax” but not
individuals directly
Paid for by contributions from France
War of 1812 had a temporary income tax
Government didn’t collect taxes, but
didn’t provide services either
History of Taxes
Civil War
1862 Lincoln instituted a progressive
income tax on wages
After war, income tax removed
16th Amendment to Constitution
1909 introduced first permanent
income tax
Ratified by ¾ of states in 1913
History of Taxes
World War I
Financed by income taxes
Social Security Act
As a result of the Great Depression,
government expanded
1935 as part of FDR’s “New Deal”
created the IRS
History of Taxes
World War II
Taxes raised to pay for war
Set precedence to pay for growing
government
Lesson 7.2
Filing Tax Returns
GOALS
Define and discuss the significance
of exemptions, dependents, and
taxable and nontaxable income on
tax returns.
Prepare Forms 1040EZ and 1040A.
Filing Status
Single person
Married person filing a joint return
Married person filing a separate
return
“Head of household”
Qualifying widow(er)
With a dependent child
Exemptions
Exemptions
Amount subtracted from income for each
person who “depends” on you to live
Don’t pay tax on this amount
Personal exemption
Exempt yourself and spouse, if filing jointly
Dependent exemption
Not limited to children
Receives more than ½ living expenses from you
Gross Income
All the income you receive
Wages, salaries, and tips
Interest income
Dividend income
Unemployment compensation
Social security benefits
Alimony
Money paid to former spouse
Taxable to receiver, deductible to payer
Others – lottery winnings, gambling, rental
income, etc.
Gross Income
Child support
Money paid by other parent to pay for
child’s living expenses
Not taxable to person that receives
Not deductible for person that pays
Adjusted Gross Income
Gross income
– Adjustments
Adjusted gross income
Taxable Income
Gross income
– Adjustments
Adjusted gross income
– Deductions
– Exemptions
Taxable income
Deductions
Itemize
If you itemize (list) your deductions, use Form
1040
You’d list your deductions on Schedule A
Common deductions
Medical/Dental Expenses
State/Local Income Taxes
Property Taxes
Home Mortgage Interest
Gifts to Charity
Losses from Theft or Property Damage
Moving Expenses
Deductions
Standard Deduction
Not many deductions, then best to
take standard deduction
Subtract set amount from adjusted
gross income without having to
itemize
Individual deductions don’t add up to
standard deduction – take standard!
Deductions
Exemptions
Talk about when we complete tax
forms
Basically, how many people live with
you
Taxable Income
Amount used to determine amount of
federal income tax due
Preparing to File
Who must file?
Those listed on P185 in your text
Even if your gross income is less than stated
amount, file a tax return so you can get a
refund!
May have to file if…
Claimed as dependent on someone else’s return
Owe special taxes
Earned $400+ from self-employment
Earned $100+ from a church organization that doesn’t
pay social security taxes
Preparing to File
When to file?
April 15 of the following year
If 4/15 falls on a weekend, then following Monday
File late – pay penalties
Know you are going to be late, file for an
extension
Short form or long form?
400+ tax forms and schedules
1040EZ, 1040A and 1040 are most common
Select based on income, deductions and complexity of
tax situation
Preparing to File
Where to begin?
Save receipts for itemized deductions all year
Save pay stubs and check W-2 when you
receive towards end of January
Gather all documents
Form 1099 DIV
Form 1099 INT
W-2 from each employer
Determine if you will itemize
Make sure you save originals or copies of
EVERYTHING when you are finished
Preparing to File
Filing electronically
1040EZ and 1040A may be submitted
electronically
Owe taxes, pay online with credit card
Quicker receipt of refund
Make sure you print a copy of your
return to save!
Form 1040EZ
According to book…
Use 1040EZ if you have taxable
income less than $50,000
NOW LIMIT IS $100,000!!
Single or married filing jointly
Under age 65
No dependents
Interest income of $1500 or less
Form 1040EZ
EXAMPLE 1
Darby L. Russell, 843 Thorn St., Sewickley, PA
15143.
Social Security Number: 155-46-7819
Does not want to contribute to presidential
campaign fund
Single and claims herself as exemption
Earned $24,500 last year as a financial analyst,
plus $650 in interest income
Taxes withheld were $3,500
Form 1040EZ
EXAMPLE 2
Rudder L. Healey, 1402 Bentley Ridge Blvd,
Lancaster, PA 17603
Social Security Number: 125-14-4447
Does want to contribute to presidential campaign
fund
Single and claims himself as exemption
Earned $9,500 last year as a waiter, plus $900 in
tips – he works part-time while going to college
He has interest earnings of $100
Taxes withheld were $479
Form 1040A
According to book…
Taxable income less than $50,000
NOW LIMIT IS $100,000!!
Capital gains distributions, but no other
capital gains or losses
Form 1040A
Only tax credits…
Child Tax
Education
Earned Income
Child and Dependent Care Expenses
Adoption Expenses
Retirement Savings Contributions
Form 1040A
Only deductions…
IRA Contributions
Student Loan Interest
Educator Expenses
Higher Education Tuition and Fees
No itemized deductions!
Form 1040
Taxable income of $50,000 or more
NOW LIMIT IS $100,000!!
Itemized deductions
Self-employment income
Income from sale of property