Introduction. Income Tax: percentage of your income collected by the government to fund its services and programs

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2 Introduction Income Tax: percentage of your income collected by the government to fund its services and programs Tax revenue pays for national defense, fire and police protection, road construction, schools, libraries, parks, etc. Income tax is automatically withheld from your paycheck by your employer. Amount depends on how you fill out your W-4 form. Internal Revenue Service (IRS) is the government body that enforces the laws and collects taxes. The IRS is a branch of the Treasury Department.

3 Taxable Income Federal income taxes are a percentage of your taxable income. Let s go through the process of finding your taxable income: 1) You first start with your Gross Income. This your total income which includes wages, tips, interest, or dividends from investments, unemployment compensation, profits from business, rental income, and even game-show winnings.

4 Taxable Income 2) We now need to determine your Adjusted Gross Income. This is found by subtracting certain allowable amounts, called adjustments, from your gross income. Adjustments: untaxed portions of your gross income Examples: Contributions to certain retirement accounts and tax-deferred savings plans, interest paid on student loans, and alimony payments.

5 Taxable Income 3) Lastly, you may be entitled to certain exemptions and deductions. These are subtracted from your adjusted gross income. Exemption: a fixed amount on your return for each person supported by your income. (It was $3800 in 2012)

6 Deductions Standard Deduction: lump-sum amount that you subtract from your adjusted gross income. The IRS sets this amount. Typically younger people choose this method because their financial situations are relatively simple and they are not eligible for numerous deductions associated with owning a home or making charitable contributions. Itemized Deduction: deductions you list separately if you have incurred a large number of deductible expenses. Includes: interest on home mortgages, state income taxes, property taxes, charitable contributions, and medical expenses exceeding 7.5% of adjusted gross income. You choose the greater of the standard or itemized deduction

7 Taxable Income

8 Income Tax Example

9 Income Tax Example Gross Income: total income which includes wages, tips, interest, or dividends from investments, unemployment compensation, profits from business, rental income, and even game-show winnings. Earned Wages: $87,200 Interest from Savings Account: $2680 Gross Income = $87,200 + $2680 = $89,880

10 Income Tax Example Adjustments: Contributions to certain retirement accounts and tax-deferred savings plans, interest paid on student loans, and alimony payments. Contributed $3200 to a tax-deferred savings plan Adjustments = $3200 So, Adjusted Gross Income = $89,880 - $3200 = $86,680 Gross Income Adjustments

11 Income Tax Example Personal Exemption of $3800 Standard Deduction of $5950 or Itemized Deduction: Interest on home mortgage was $11,700 Paid $4300 in property taxes Paid $5220 in state taxes Contributed $15,000 to charity Itemized Deduction = $11,700 + $ $ $15,000 = $36,220

12 Income Tax Example Personal Exemption of $3800 Standard Deduction of $5950 or Itemized Deduction of $36,220 Choose Itemized since it is the largest. Therefore, Taxable Income = $86,680 ($ $36,220) = $46,660

13 Income Tax We have determined how to find the taxable income. Now we want to determine the Income Tax. A tax table is used to determine how much you owe based on your taxable income. However, you may be entitled to some Tax Credits. The credit reduces income tax by the dollar-for-dollar amount of credits.

14 Income Tax Employer deducts federal taxes through withholding based on a percentage of your gross pay. When you file your tax refund you are finding the difference between what you owe and what you already paid. Typically you pay more than what you owe and therefore get a tax refund. If you owe money, you need to pay by April 15 th for the tax from the previous year.

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16 Income Tax Table 8.1 (Page 501) shows the 2012 Marginal Tax Rates, Standard Deductions, and Exemptions for four filing status categories. Say you are single and your taxable income is $20,000. You are in the 15% tax bracket. Your marginal rate is 15%. This means you pay 10% for the first $8700 of taxable income and then 15% of the rest ($11,300).

17 Income Tax

18 Example 2

19 Example 2 Adjusted Gross Income = $40,000 - $1000 = $39,000

20 Example 2 Look at Table 8.1 Exemptions = $3800 Standard Deduction = $5950 Itemized Deductions = $ $ $300 = $4800 We choose the Standard Deduction. Therefore, Taxable Income = $39,000 ($ $5950) = $39,000 - $9,750 = $29,250

21 Example 2 Tax Computation: Table 8.1 ($29,250 taxable income) Owe 10% of first $8700 and 15% on income between $8701 and $35,350 Income Tax = $ 3, $0 = $3,952.50

22 Social Security and Medicare (FICA) In addition to income tax, we are required to pay FICA (Federal Insurance Contributions Act) taxes. FICA: Social Security and Medicare Social Security: provides payments to eligible retirees, people with health problems, eligible dependents of deceased persons, and disabled citizens. Medicare: provides health care coverage to Americans 65 and older.

23 Social Security and Medicare (FICA) 2012 FICA Tax Rates: Cannot subtract adjustments, exemptions, or deductions when determining FICA taxes

24 Social Security and Medicare (FICA) If you are not self-employed and earn $200,000, what are your FICA taxes? 5.65% on first $110, % on the rest of income

25 Taxes for a Working Student Employers withhold federal, state, and FICA taxes. Your pay stub provides information on the money you earned and includes your gross and net pay. Gross Pay (Base Pay): salary prior to withheld taxes Net Pay: actual amount on check after taxes withheld

26 Taxes for a Working Student

27 Weekly Gross Pay is the number of hours worked times your hourly wage. $200 is how much you make before taxes

28 Your employer withholds 10% of your gross pay for federal taxes $20 is taken out of your paycheck for federal taxes

29 Your employer withholds 5.56% of your gross pay for FICA taxes $11.30 is taken out of your paycheck for FICA taxes

30 Your employer withholds 3% of your gross pay for state taxes $6 is taken out of your paycheck for state taxes

31 Net Pay is the amount you receive after you subtract all of the withheld taxes from the gross pay This is the actual amount on your paycheck

32 We want to know what percent of $200 is $ % of your gross pay goes directly to taxes by your employer

33 Pay Stub

34 Practice Problems Page 506 Find Gross Income, etc.: #1, 2, 3, 4 Use Table 8.1: #5, 6, 7, 9 Find Income Tax: #15, 16 FICA: #19, 21, 23 Pay Stub: #25