Tax Preparation
Financial Literacy
Federal Income Tax Structure
 The Federal income tax is a
progressive tax
 The higher your income, the more you
pay, both as a dollar amount and as a
percentage.
 Tax Freedom Day (see Facts of Life,
page 102)
 Almost four months of your yearly income goes to
pay various taxes (30%)
Tax Vocabulary
 Tax Brackets:
 Income ranges in which the same tax rates
apply
 For example: 15%, 25%, 35%, etc.
 Personal Exemptions:
 An allowed reduction in your income before
taxes are computed
 You get one for yourself, one for your spouse,
and one for each dependent
Tax Vocabulary, continued
 Deductions are:
 Expenses that reduce taxable income, such
as:
 Some medical expenses
 Mortgage interest paid
 State and local income taxes
 Charitable contributions
 Itemized Deductions (expenses):
 Deductions are calculated using Schedule A
Tax Vocabulary, continued
 Standard Deduction:
 A set deduction allowed by the IRS regardless
of your actual expenses
 You can itemize deductions or take the
standard deduction, but not both
 Taxable Income:
 Income subject to taxes after deductions and
exemptions are subtracted from gross income
Tax Example
 Gross income – exemptions – deductions =
Taxable Income
 Assuming you are married filing jointly with
gross income of $70,000 and taxable income of
$49,423, your taxes would be $6,564 (see
Figure 4.4 on page 109)
Marginal Tax Rate
 This chart shows the
highest tax rates
charged for the
highest incomes over
the last 100 years.
 The Fiscal Cliff
agreement raised the
highest tax rate to
39.6% on the highest
earners
Average vs Marginal Tax Rates
 Marginal tax rates are the percentage paid
on your highest level of income
 Marginal tax rate in the example is 25%
 Average tax rates are your actual taxes
divided by your taxable income (will be
lower than the marginal rate):
 $6,564/$49,423 = 13.28%
 Or by your gross income:
 $6,564/$70,000 = 9.38%
Filing Status
 Single:
 You are single at the end of the year with no
dependents
 Married filing jointly:
 You and your spouse combine incomes
 Married filing separately:
 You and your spouse file separate returns
 Head of Household:
 You are unmarried but have at least one dependent
child living with you
Other Taxes You Pay
 Social Security (FICA)
 6.2% for Social Security
 1.45% for Medicare
 State and local income taxes
 Excise taxes:
 Sales taxes, gas taxes, property taxes, taxes
on liquor, cigarettes, jewelry, air travel, etc.
 Gift and estate taxes
Who Has To File A Return?
 If your income is greater than
$20,900
 If it is less than that, you might
not need to file, depending on
your circumstances (check with
your tax advisor)
 However, if your income is less
than that and if you had taxes
withheld, you will not get a
refund unless you file a return.
Itemizing Deductions
 The most common deductions are:
 Medical and dental expenses exceed 7.5% of
adjusted gross income
 Tax expenses (state and local can be deducted, but
not Federal, Social Security, or sales taxes)
 Home mortgage interest
 Charitable contributions
 Casualty and theft losses
 A deduction will lower your tax bill, but not dollar
for dollar
Standard Deduction
 The standard deduction is the
government’s best estimate on what the
average person would be able to deduct
by itemizing
 Remember that you can take the standard
deduction or you can itemize, but not both
 See Figure 4.2 for standard deduction
amounts (page 106)
Exemptions
 Personal
 Take one for yourself and one for your spouse
 Dependents:
 Must have a qualifying relationship (child, grandchild,
parents, stepparents, uncles, nieces, etc.)
• The dependent can’t earn more than the exemption
amount
does not apply to children under 19 or to children
under 24 if full-time students
 Must provide more than half of dependent’s financial
support
Tax Formula
Gross Income:
Sum of Income
from all sources
Less
Adjustments to gross
income: tax-deductible
expenses and retirement
contributions (IRA, 401K),
moving expenses, etc.
Equals
Adjusted Gross Income
Less
Equals
Taxable income
Exemptions and
deductions
Calculating Your Base Income Tax
 For most taxpayers,
this is calculated
using tax tables (see
page 109)
 Tax tables have tax
brackets built in
 Once taxes have
been calculated,
credits can be
deducted
Common Income Tax Credits
 Tax credits will lower your tax bill, dollar for
dollar. Examples:
 Child Tax Credit (this can become a refund for
parents who don’t pay taxes) up to $1000 per child
 American Opportunity Credit
 Credit for tuition, up to $2500 of the first $4,000 of
educational expenses
 Child and dependent care credit
 Credit for money paid for child or other dependent care
 Earned income credit
 For low-income families, may result in negative taxes paid
Income Tax Due
Base Income Tax
Less
Tax Credits
Equals
Total Income Tax Due
Picking a Tax Form
 Options: 1040EZ, 1040A, or 1040
 1040EZ:
 No dependents, taxable income less than
$50,000, no itemizing deductions
 1040A:
 No itemizing, alimony, capital gains, pension
or Social Security benefits; income less than
$50,000
 1040: everyone else