Liberty Tax Service
Online Basic Income Tax
Course.
Lesson 4
HOMEWORK CHAPTER 3
Homework 1 - 1
2
HOMEWORK CHAPTER 3
Homework 1 - 2
3
HOMEWORK CHAPTER 3
Homework 1 - 3
4
HOMEWORK CHAPTER 3
Homework 1 - 4
5
HOMEWORK CHAPTER 3
Homework 1 - 5
6
HOMEWORK CHAPTER 3
Homework 1 - 6
7
HOMEWORK CHAPTER 3
Homework 2 - 1
Wilke (Parent would qualify her for H/H if
she was not married. Parent does not
make her eligible to be considered
unmarried.)
8
HOMEWORK CHAPTER 3
Homework 2 - 2
Jones (Filing Status 2, Married Filing Joint
is also acceptable)
9
HOMEWORK CHAPTER 3
Homework 2 - 3
Lizo
10
HOMEWORK CHAPTER 3
Homework 2 - 4
DeMarco
11
HOMEWORK CHAPTER 3
Homework 2 - 5
King
12
Chapter 4: Wages, Salaries, Tips, Etc.
and Withheld Taxes
Chapter Content
 Form W-2
 Wages and Other Compensation
 Tip Income
 Other Line 7 Income
 Nontaxable Compensation
 Withheld taxes
 Key Ideas
Objectives
 Know the Difference Between Taxable and Nontaxable
Income
 Understand the Types of Employee Compensation
 Use Form W-2 to Report Employee Compensation
 Understand the Ways Tip Income is Reported
 Recognize How Your tax is Paid by Withholding
13
Taxable Income
Taxable income.
1. All income in the form of money, goods,
services, and property you receive during the
tax year that is subject to income tax
2. Includes earned income and unearned income
 Earned income is income from personal
services such as wages and other
employee compensation
 Unearned income is non-personal service
income such as interest and dividends
3. Reported on lines 7 through 21 of Form 1040.
14
Nontaxable Income
Nontaxable or exempt income (not subject
to income tax).










Child support
Federal tax refunds
Interest on municipal bonds
Public assistance payments
Workers’ compensation
Most life insurance proceeds received upon
death
Part or all of social security benefits
Veteran’s disability benefits
Gifts, bequests, and inheritances (may be
subject to other taxes)
Some nontaxable income, such as exempt
interest, must be shown on Form 1040 but is not
added to gross income.
15
Wages, Salaries and Tips
Wages, salaries, and tips that are earned as an employee
are probably the most familiar types of income.
The most common types of income:
 Wages and salaries are compensation paid by your
employer for work or services you provide
 Tips are received from customers
 Compensation also includes awards, bonuses, sick pay,
and other taxable employee benefits
 Wage and tip income and other compensation can be in
the form of cash or goods, services, and property
 All such income that is not specifically excluded by law
from taxation is taxable and must be reported.
16
Form W-2
Form 1040, Page 1
17
Form W-2
Reports wage and tip income, tax withholding and
other related information to you and to the IRS.
1. Employer must provide by January 31
2. Box 1 of Form W-2 reports total wages, tips,
and other compensation which is entered on
line 7 of Form 1040
3. Some of Form W-2 boxes provide information
about the box 1 amount; this information is
not entered on Form 1040
4. If box 1 information is incorrect, employer
must issue Form W-2c
5. If you have more than one W-2, add the
amounts in each box 1 and enter the total on
line 7
6. Even if you do not receive Form W-2 from
your employer, you must still report the
income.
18
Statutory Employees
Statutory employees include full time life
insurance agents, certain home workers,
and traveling salespeople.




Income is reported on Form W-2
Statutory employee in box 13 of Form W-2 is
checked
If there are no expenses related to income,
enter box 1 amount on line 7 of Form 1040
If there are expenses, complete Schedule C
and enter net income on line 12 of Form 1040.
19
Wages And Other Compensation
Compensation reported in box 1 that must be
entered on line 7 of Form 1040 includes: regular
pay; advance commissions; back pay awards;
bonuses and awards; sick pay; holiday gifts;
severance pay; travel and other business
expense reimbursements; employer provided
vehicles; supplemental unemployment benefits;
disability income from an employer-paid plan
received before you reach minimum retirement
age, whether reported on Form W-2 or Form
1099-R (covered in Chapter 9).
The amount shown in box 1 of Form W-2 is gross
pay before federal and state income taxes, social
security and Medicare taxes and other
withholdings are taken out.
20
Wages and Income – Problem 1
Lorenzo P. Lake’s salary for 2008 was
$35,000. Lorenzo’s take home pay was
$28,129.50 because his employer withheld
social security, Medicare and federal
income taxes of $6,870.50. Which amount
will be reported in box 1 of his Form W-2?
a. $28,129.50
b. $35,000.00
c. None of the above
21
Wages and Income – Problem 1
Lorenzo P. Lake’s salary for 2008 was $35,000. Lorenzo’s take home
pay was $28,129.50 because his employer withheld social
security, Medicare and federal income taxes of $6,870.50. Which
amount will be reported in Box 1 of his Form W-2?
b. $35,000.00
22
Wages and Income – Problem 2
Corey was employed by the Ace Insurance Company,
her salary in 2008 was $29,000. She was given a
Christmas bonus of $500. Corey won a sales contest
in November 2008 and the prize was a 4 day vacation
to Florida. The value of the vacation prize (cost of the
airline tickets and hotel) was $1,200. She did not
actually take the vacation until February 2009. What
is the total compensation that her employer should
report in box 1 of Form W-2?
a.
b.
c.
d.
$29,500
$29,000
$30,700
$30,200
23
Wages and Income – Problem 2
Corey was employed by the Ace Insurance Company,
her salary in 2008 was $29,000. She was given a
Christmas bonus of $500. Corey won a sales contest
in November 2008 and the prize was a 4 day vacation
to Florida. The value of the vacation prize (cost of the
airline tickets and hotel) was $1,200. She did not
actually take the vacation until February 2009. What
is the total compensation that her employer should
report in box 1 of Form W-2?
c. $30,700
$29,000 salary + $500 bonus + $1,200 prize awarded in 2007 =
$30,700. The amounts of the bonus and prize included in box 1
may be broken out and shown in box 14 of Form W-2.
24
Tip Income
All cash and non-cash tips received from customers
are taxable income and must be reported on line 7 of
Form 1040.
You must keep a daily tip record so you can:
 Report tips to your employer
 Report tips accurately on your tax return
 Prove tip income if your return is
questioned
25
Tip Income
Include the value of all noncash tips such as tickets or passes.
26
Reporting Tips To Your Employer
Report to your employer cash, check, or
credit card tips of $20 or more for any
one month for any one job.
1. These tips are included in the amount shown
in box 1 of Form W-2
2. Your employer withholds social security and
Medicare taxes for these tips from your wages
3. Any social security and Medicare taxes not
collected by your employer must be reported
as additional tax on your return
4. Do not report the value of noncash tips to
your employer
5. If you do not report tips of $20 or more as
required, you may be subject to a penalty.
27
Reporting Tips To Your Employer – Problem 3
Zachary works at Uncle Sam’s Restaurant as a
waiter. He keeps a daily tip record. He
received only cash tips in 2008. His tips in
June were $17. Every other month his tips
were $20 or more. Is Zachary required to
report his June tips to his employer?
Yes or No?
28
Reporting Tips To Your Employer – Problem 3
Zachary works at Uncle Sam’s Restaurant as a
waiter. He keeps a daily tip record. He
received only cash tips in 2008. His tips in
June were $17. Every other month his tips
were $20 or more. Is James required to
report his June tips to his employer?
No.
29
Tips Not Reported To Your Employer
Do not report tips under $20 a month or to your
employer.
 These tips are subject to income tax but not social
security or Medicare tax
 Add these tips and the value of noncash tips to your
box 1 wages and enter the total on line 7 of Form
1040
 If you did not report tips of $20 or more per month
to your employer as required, also add these tips to
the amount entered on line 7
 Use Form 4137 to figure and report social security
and Medicare tax on these tips.
30
Tips Not Reported – Problem 4
Bob works for Tanya’s beauty shop. His salary is $18,000. Bob
keeps a daily tip diary. One month he made $32 in tips and
another month he made $26. He reported these tips to his
employer as required and his employer included them in box 1
of Bob’s 2008 Form W-2 that showed total compensation of
$18,058. The other 10 months Bob did not make more than
$19 in cash tips in any month, so he was not required to report
these tips to his employer. He received total cash tips for the
year of $175 that he did not report to his employer. One of his
customers also tipped Bob with passes to the County Fair. The
value of the passes was $12. What is the total income that Bob
must report in box 1 of his Form W-2 and on line 7 of Form
1040?
a. $18,058
b. $18,245
c. $18,233
31
Tips Not Reported – Problem 4
Bob works for Tanya’s beauty shop. His salary is $18,000. Bob
keeps a daily tip diary. One month he made $32 in tips and
another month he made $26. He reported these tips to his
employer as required and his employer included them in box 1
of Bob’s 2008 Form W-2 that showed total compensation of
$18,058. The other 10 months Bob did not make more than
$19 in cash tips in any month, so he was not required to report
these tips to his employer. He received total cash tips for the
year of $175 that he did not report to his employer. One of his
customers also tipped Bob with passes to the County Fair. The
value of the passes was $12. What is the total income that Bob
must report in box 1 of his Form W-2 and on line 7 of Form
1040?
b. $18,245
32
Tips Not Reported To Your Employer
BOB’S
BOB’S
WAGES,
WAGES, PLUS
PLUS
THE THE
TIPS HE
TIPS
REPORTED
HE
REPORTED
TO HIS
TO
EMPLOYER
HIS
EMPLOYER
+ Unreported cash tips ($175)
+ Value of non-cash tip ($12)
= $18,245
Form 1040
33
Allocated Tips
Allocated tips are tips that are assigned to you by your
employer in addition to the tips you report to the
employer.
1.
Tip allocation is only required if you work for certain food
and drink establishments and your reported tips are less
than your share of a required percentage of food and
drink sales
2.
Allocated tips are shown in box 8 of Form W-2 and must
be included in your gross income unless you have proof of
actual tips
3.
If you have to include allocated tips in your income, add
the amount in box 8 to the box 1 amount, enter on line 7
of Form 1040 and complete Form 4137 to figure the social
security and Medicare tax you owe
4.
You must use Form 1040 if reporting allocated tip income.
34
Allocated Tips – Problem 5
In 2008, Hope reported $400 in total tips to
her employer. Her employer reported wages
of $16,580, which included those tips. Box 8
of her Form W-2 showed allocated tips of
$484. How much income would Hope report
Form 1040, line 7?
a. $16,980
b. $16,580
c. $17,064
35
Allocated Tips – Problem 5
In 2008, Hope reported $400 in total tips to
her employer. Her employer reported wages
of $16,580, which included those tips. Box 8
of her Form W-2 showed allocated tips of
$484. How much income would Hope report
Form 1040, line 7?
c. $17,064
36
Allocated Tips – Problem 5
+
Form 1040, Page 1
=
$17,064
37
OTHER FORM 1040 LINE 7 INCOME
The following are some of the types of income that are either
not reported on a Form W-2 or not included in box 1 that
must be reported on line 7 of Form 1040:
1. The taxable portion of scholarships and fellowships not
reported on Form W-2. Write “SCH” and the amount not
reported on Form W-2 in the space to the left of line 7. If
you are a degree candidate, only those amounts not used
for tuition and other course related expenses are taxable.
2. Wages received as a household employee that were not
reported on a Form W-2 because an employer paid less
than $1,500. Write “HSH” and the amount not reported
on a Form W-2 in the space to the left of line 7.
38
OTHER FORM 1040 LINE 7 INCOME
3. The amount of dependent care benefits shown
in box 10 of Form W-2 that you cannot exclude
from your income. Dependent care benefits are
amounts an employer paid to an employee or
paid out on behalf of an employee for child and
dependent care services.
4. Any amount of employer provided adoption
benefits or moving expense reimbursements
that are not excludable. If these benefits were
received, the amounts are shown on Form W-2
in box 12.
39
Form 1099-MISC Income
If income is reported by the payer in box 7
of Form 1099-MISC, you are being
reported as self-employed.



Report your income on Schedule C and line 12
of Form 1040
You may also owe self-employment tax on
income reported on Form 1099-MISC
Use the SS-8 questionnaire to help you
determine if you are an employee or an
independent contractor
40
Nontaxable Employee Compensation
Many fringe benefits you receive from your
employer are tax free or tax deferred because
you pay fair market value for them or they
are specifically excluded by law from taxable
income.
A tax-free fringe benefit is never included in
your gross income and you will never pay tax
on it. Examples of tax-free benefits are:
 Health care benefits
 Group term life insurance up to $50,000 of
coverage
41
Nontaxable Employee Compensation
A tax-deferred benefit is not included in gross income
in the year you receive it and so is not taxed in the
year received.
 Your employer’s contributions to a qualified
retirement plan
 Your contributions for retirement under a
qualified deferred compensation plan set up by
your employer, such as a 401 (k) plan
 Contribution limited to $15,500 in 2008
($20,500 if age 50 or over)
 Any amount over that is subject to income tax
in the year you receive it
 Contributions to a deferred compensation is
shown in box 12 of Form W-2 with the code
letter D
42
Nontaxable Employee Compensation
 Social security and Medicare taxes are
collected on this deferred compensation in the
year you receive it
 Social security and Medicare wages shown in
boxes 3 and 5 of Form W-2 will include this
deferred compensation and be different from
the amount shown in box 1.
Retirement plan distributions are taxed in the
year you withdraw them from your retirement
plan.
43
Nontaxable Employee Compensation
Jack D. Sprat’s salary is $28,640. He participates in
his employer’s 401(k) plan. In 2008, Jack
contributed $1,400 of his salary to the plan.
Jack’s Form W-2 is shown below.
44
Withheld Taxes
Federal income tax is a pay-as-you-earn tax.
 You owe tax on income as you earn or
receive it
 Must pay the tax you owe as you receive the
income.
Paid in one of two ways:
 Withheld from your wages , or
 Make estimated tax payments.
If you do not pay enough tax during the year,
you may owe a penalty in addition to the tax
that is still due.
45
Withheld Taxes
WITHHELD TAXES are tax payments withheld
from your income and made to the IRS in
your name during the year by the payer of
the income.
If you are an employee, your employer will
withhold income tax payments from your
pay based on the amount you earn and the
information you give your employer on Form
W-4.
46
Withheld Taxes
Other types of income from which taxes must
be or may be withheld:

Unemployment compensation

Gambling winnings

Pensions

Social security benefits

Interest and dividend payments
The taxes withheld during the year from your
income determine whether you owe money
or whether you will receive a refund.
47
Mandatory Withholding
 Taxes must generally be withheld from
wages, from some gambling winnings and in
certain cases from interest and dividend
payments. For some types of required
withholding the withholding rate is also set
by law.
48
Salaries and Wages
 Your employer withholds the tax you owe on your
wages or other employee compensation. Federal
income tax your employer is required to withhold
from your pay is based on the amount you earn and
the information you provide on Form W-4. You must
complete a Form W-4 when starting a new job.
49
Salaries and Wages
The W-4 includes three types of information your
employer will use to figure your withholding:
 Whether to withhold at the single or the lower
married rate (the higher the rate, the more tax is
withheld)
 How many withholding allowance you claim (each
allowance reduces the amount withheld)
 Whether you want an additional amount withheld (so
that you are paying more of your tax liability during
the year)
50
Form 1040, Page 2
 Enter the withholding on line 62 of Form 1040.
 If you worked for more than one employer during the
year, add the amounts in box 2 from all your W-2
forms and enter the total on line 62.
 If you are married filing jointly, add the box 2
amounts from all the W-2 forms for each spouse and
enter the total on line 62 of Form 1040.
Form 1040, Page 2
51
Wages, Salaries, Tips, Etc. and
Withheld Taxes
Key Ideas

The total of all taxable compensation earned as an
employee is entered on line 7 of Form 1040. Taxable
employee compensation includes payment given in the
form of bonuses, awards, strike benefits, and severance
pay in addition to salary or wages.

In general, the amount entered on line 7 is the amount
from box 1 of Form W-2 that your employer provides to
you. If more than one Form W-2 is received, add the
amounts from box 1 of each Form W-2 and enter the total
on line 7.

Tip income that was not reported to your employer or
allocated tips from Form W-2, box 8, must be added to the
amounts reported in box 1 and report the total on line 7.
52
Wages, Salaries, Tips, Etc. and
Withheld Taxes
Key Ideas

Other income that must be reported on line 7
includes scholarships and fellowships, household
employee income not reported on a Form W-2, and
the nonexcludable portion of certain fringe benefits
such as dependent care benefits.

Deferred compensation is the part of pay received
by an employee that is contributed to a qualified
retirement arrangement set up by an employer.
While this income is not subject to tax when
contributions are made, it is subject to tax when
plan contributions are withdrawn.
53
Wages, Salaries, Tips, Etc. and
Withheld Taxes
Key Ideas
 You are expected to pay at least 90% of your income
tax liability as you receive income during the year.
 Withholding is one way income tax is paid as it
comes due. The payer withholds tax payments from
your income and sends these to the IRS. The most
common type of withholding is from your pay by your
employer.
54
Wages, Salaries, Tips, Etc. and
Withheld Taxes
KEY IDEAS
 The amount of your pay and the information provided on
Form W-4 determine the amount of tax your employer
withholds.
 Withholding from your pay is mandatory. You generally do
not have the option of having no tax withheld from your
pay. You can choose to have income tax withheld from
other types of income such as unemployment
compensation or social security benefits.
 If you do not have enough tax withheld to pay your tax
liability, you have to pay the difference with your tax
return. If the tax withheld is more than your tax liability,
you are due a refund of the overpayment.
55
Wages, Salaries, Tips, Etc. and
Withheld Taxes
Classwork 1. True or False.
1) Employee bonuses are not included in gross income.
2) Most taxable compensation you receive as an employee is
shown in box 1 of Form W-2.
3) Tips are not taxable income.
4) The amounts shown in each box on Form W-2 are entered
on your tax return.
5) Taxable employee compensation is reported on line 7 of
Form 1040.
6) If the amount shown in box 1 of Form W-2 is incorrect,
you should cross it out and write in the correct amount.
56
Wages, Salaries, Tips, Etc.
Classwork 1. True or False.
7)
Box 8 of Jackie’s Form W-2 shows allocated tips of $340. If
Jackie cannot prove she received a smaller amount of tips, she
must include $340 in the amount she enters on line 7 of Form
1040 and she must complete Form 4137.
8)
Joe contributes part of his salary to the 401(k) retirement plan
set up by his employer. Joe will never have to pay tax on these
contributions.
9)
Generally, withholding of federal taxes is required on all
employee compensation.
10) In 2001, Carol (born 2/2/1949) retired on disability from her
job at Starr Industries. The minimum retirement age at Starr is
62 years of age. For the 2008 tax year, Carol reports the
disability pension payments she received from Starr on line 7 of her
Form 1040.
57
Wages, Salaries, Tips, Etc. and
Withheld Taxes
Classwork 1. True or False.
1) Employee bonuses are not included in gross income. F
2) Most taxable compensation you receive as an employee is
shown in box 1 of Form W-2. T
3) Tips are not taxable income. F
4) The amounts shown in each box on Form W-2 are entered
on your tax return. F
5) Taxable employee compensation is reported on line 7 of
Form 1040. T
6) If the amount shown in box 1 of Form W-2 is incorrect,
you should cross it out and write in the correct amount. F
58
Wages, Salaries, Tips, Etc. and
Withheld Taxes
Classwork 1. True or False.
7)
Box 8 of Jackie’s Form W-2 shows allocated tips of $340. If
Jackie cannot prove she received a smaller amount of tips, she
must include $340 in the amount she enters on line 7 of Form
1040 and she must complete Form 4137. T
8)
Joe contributes part of his salary to the 401(k) retirement plan
set up by his employer. Joe will never have to pay tax on these
contributions. F
9)
Generally, withholding of federal taxes is required on all
employee compensation. T
10) In 2001, Carol (born 2/2/1949) retired on disability from her
job at Starr Industries. The minimum retirement age at Starr is
62 years of age. For the 2008 tax year, Carol reports the
disability pension payments she received from Starr on line 7 of her
Form 1040. T
59
Wages, Salaries, Tips, Etc. and
Withheld Taxes
CLASSWORK 2: Should the following types of compensation be included in
box 1 of Form W-2? Yes or No.
1)
A vacation trip you were awarded as a prize for meeting
sales goals.
2)
Your employer’s contribution to a qualified retirement
plan.
3)
The ham your employer gave you for Christmas.
4)
Employer provided vehicles used for personal driving,
including commuting to and from work.
5)
Payments received from your employer while you were
out with a broken leg.
60
Wages, Salaries, Tips, Etc. and
Withheld Taxes
CLASSWORK 2: Should the following types of compensation be included in
box 1 of Form W-2? Yes or No.
1)
A vacation trip you were awarded as a prize for meeting
sales goals. Y
2)
Your employer’s contribution to a qualified retirement
plan. N
3)
The ham your employer gave you for Christmas. N
4)
Employer provided vehicles used for personal driving,
including commuting to and from work. Y
5)
Payments received from your employer while you were
out with a broken leg. Y
61
Wages, Salaries, Tips, Etc. and
Withheld Taxes
CLASSWORK 3: Multiple choice.
1)
Shea is a waitress. The amount in box 1 of her Form W-2 is $17,540.
She reported tips as required to her employer. Her reported tips totaled
$2,489. Her unreported tips totaled $37. What is the amount of her tips
included in the box 1 of her Form W-2?
a. $2,489
b. $2,526
c. $0
1)
How much does Shea have to include on Form 1040, line 7?
a.
b.
c.
d.
$17,540
$17,577
$20,029
$20,066.
62
Wages, Salaries, Tips, Etc. and
Withheld Taxes
CLASSWORK 3: Multiple choice.
3)
James is a waiter. The amount in box 1 of James’s Form W-2 is
$14,722. He reported tips of $1,554 to his employer. Box 8 of his Form
W-2 shows the amount of $412 and James does not have records to
dispute this amount. What amount will James enter on line 7 of Form
1040?
a. $16,688
b. $15,134
c. $14,722
d. $16,276
4)
Which of the following is an example of unearned income?
a. Wages
b. A bonus from your employer
c. Sick pay
d. Unemployment compensation
63
Wages, Salaries, Tips, Etc. and
Withheld Taxes
CLASSWORK 3: Multiple choice.
1)
Shea is a waitress. The amount in box 1 of her Form W-2 is $17,540.
She reported tips as required to her employer. Her reported tips totaled
$2,489. Her unreported tips totaled $37. What is the amount of her tips
included in the box 1 of her Form W-2? a. $2,489
2)
3)
How much does Shea have to include on Form 1040, line 7?
b. $17,577 ($17,540 from box 1 plus $37)
4)
James is a waiter. The amount in box 1 of James’s Form W-2 is
$14,722. He reported tips of $1,554 to his employer. Box 8 of his
FormW-2 shows the amount of $412 and James does not have records
to dispute this amount. What amount will James enter on line 7 of Form
1040? b. $15,134 ($14,722 from box 1 plus $412)
5)
6)
Which of the following is an example of unearned income?
d., unemployment compensation
64
Questions and Answers
65