Chapter 6

Paying Taxes

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 Learning Objectives

Describe the basic principles of taxation and

the major categories of taxes.
Explain payroll taxes
Describe the purpose and process of filing
tax returns
Explain how taxes affect your financial plan

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 Tax Basics

Tax is money collected by a government from its

citizens for the purpose of operating the
government
Gross pay is the total amount of money you earn
Take-home pay is the amount of money you get to
keep and use
Net Pay is the amount of money you take home

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 Tax Basics

Everyone pays taxes

Taxes pay the cost of government
The government levies taxes on different things
States can have different taxes too
There are all different types of taxes, such as:
Sales Taxes
Real Estate Taxes
Payroll Taxes

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 Sales Tax

Sales tax is tax Some of the price we pay for an

on purchases at
a store
item is a tax
The merchant collects this money
and sends it to the government
The federal government does not
impose a sales tax
Many state governments do impose
a sales tax

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 Real Estate Tax

Governments calculate real estate taxes based

on the value of the property
The government sends the property owner a
bill for this tax
These taxes are primarily used to fund local
schools
They also vary significantly from state to state
and county to county.

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 Payroll Taxes

Many people pay taxes every time

Payroll Taxes are they get paid
taxes on your
paycheck These taxes can include federal and
state income taxes and social security
(or FICA) withholdings.
People who are self employed do not
have taxes withheld from their
earnings.
See figure 6.1 for an example of a pay
stub

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 Figure 6.1

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 The Internal Revenue Service

Internal revenue The IRS is a branch of the

service (IRS) is the
government body that
United States Treasury
carries out the federal Department
tax system They enforce the tax laws and
collect taxes
Each year in which you earn an
income over a certain amount,
you need to file a federal tax
return with the IRS

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 The Internal Revenue Service

Tax returns report A tax return consists of a form

to the IRS all the
information relative
called 1040 or 1040EZ (see Figure
to your income 6.2 a &b)
taxes On this form you need to include
how much income you earned and
how much you paid to the IRS
You will either receive a refund or
pay the difference to the
government if you owe money

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 Figure 6.2a

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 Figure 6.2b

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 The Internal Revenue Service

Taxes are figured based on your earnings from

January to December
When the year is over, you have until April 15th to
file your return
Many careers involve helping people take
advantage of tax laws to pay the lowest possible tax
Attorneys and accountants make good incomes by
helping people with tax issues

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 Check Your Financial IQ

What is the major purpose of taxes?

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 Check Your Financial IQ

Taxes pay the cost of government

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 Understanding Payroll Taxes

Personal Income Taxes are Payroll taxes include:

federal income taxes and state
income taxes (the states that Social Security and
have them) Medicare taxes
Social Security provides
payments to eligible retirees and Personal income
disabled people
Medicare provides health care
taxes (state and
coverage to mostly older federal)
Americans and some younger
disabled people

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 Social Security and Medicare

For most Americans, earned income is subject to

FICA taxes
FICA taxes are withheld from your paychecks and
sent to the government
These withholdings fund Social Security and
Medicare
For both Social Security and Medicare, your
employer matches your contributions and sends the
total amount to the government

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 Social Security and Medicare

Your portion of the Social security tax is

equal to 6.20 percent of your salaryup to a
specific income level
This amount is linked to inflation and
increases slightly every year
There is no cap on the amount of earnings
subject to the Medicare tax

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 Personal Income Taxes

Personal income taxes is the income reported on

your tax return
Many people use a tax professional or tax
preparation software for returns.
These programs guide you through preparing your
tax returns and include all the necessary forms
Refer to Figure 6.3 for the IRS table of individual
tax rates

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 Figure 6.3

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 Other Income Taxes

Many people pay a state income tax,

depending on where they live
Some cities also collect income taxes
Take a look at figure 6.4 for a listing of
states with the highest and lowest tax rates

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 Figure 6.4

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 Check Your Financial IQ

What are the payroll taxes?

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 Check Your Financial IQ

Federal and state income taxes, Social

Security, and Medicare are payroll taxes

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 Filing Taxes

A tax return form allows you to record

several different categories of information,
including:
Filing Status
Exemptions
Gross Income
Adjusted gross income
Tax and credits

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 Filing Status

Taxpayers need to specify a filing status when they

submit their income tax return
They must choose one of the following options:
Single
Married filing jointly
Married filing separately
Head of household
Qualifying widow(er) with dependent child

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 Filing Status

Tax rules and rates differ depending on which

status you choose
Until the age of 18, most of you will be
considered dependents by the IRS

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 Gross Income or Total Income

Gross income is The first step in calculating the

the total income
consisting of the
federal tax you owe is to determine
total amount of a your gross income
persons income Your employer will send you a W-2
from (almost)
any source form that details how much money
you made
See Figure 6.5 for a sample W-2
form

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 Figure 6.5

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 Gross Income or Total Income

Other forms of income include interest

Capital gains occur income, dividend income, and capital
when you sell an asset gains
for more than what Gross income also includes income from
you paid for it tips, rental properties, and business
income.
Some types of income are not included in
gross income and therefore are not taxes,
such as:
Insurance reimbursements
Child support payments
Veterans welfare benefits

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 Adjusted Gross Income

Adjusted gross The next step in filing a tax

income is figured by
taking the total
return is to figure your adjusted
income and gross income, or AGI.
subtracting certain The allowable amounts include :
allowable amounts
contributions to certain retirement
accounts
alimony payments
interest paid on student loans

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 Deductions and Exemptions

Standard deduction is a You may be able to claim

fixed amount all people various deductions and
are allowed to deduct
from their AGI to reduce
exemptions that will reduce
their tax liability the amount of your AGI that is
Itemized deductions are subject to your income taxes.
specific expenses that, These deductions include:
under tax law, can be
deducted from income to Standard deduction
reduce the amount of
Itemized deduction
income subject to income
tax

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 Deductions and Exemptions

Congress has approved certain items as tax

deductible in order to encourage certain behaviors
For example, Congress encourages home
ownership
Homeowners can deduct the interest paid on a
mortgage loan and the real estate taxes they pay

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 Refund or Payment

Accurate completion of your tax return will

show you if you need to pay additional
income taxes or if you will receive a refund
In most cases, you will not receive a refund
unless you pay taxes during the year

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 Check Your Financial IQ

When does a person file his or her taxes?

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 Check Your Financial IQ

A person fills out a tax return by April 15 of

each year

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 Taxes and Your Financial Plan

People want to lower their tax liability to the lowest

possible level for their income
They will keep more of their own money rather
than paying it to the government in taxes
Tax planning influences both your short-term and
long-term future
Consider the tax implications of your financial life
at all stages

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 Check Your Financial IQ

Why are taxes an important part of your

financial plan?

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 Check Your Financial IQ

You must consider the tax consequences of

all your financial decisions because the tax
impact may make one course of action better
than another

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 Summary

Taxes are monies the government collects from citizens

for the purpose of operation the government
The government collects taxes in a variety of ways and
forms:
Sales taxes
Real estate taxes
Payroll taxes
The IRS is the governmental body that carries out the
federal tax system

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 Summary

Payroll taxes include personal income taxes (state

and federal) and Social Security and Medicare taxes
Social Security and Medicare taxes are also known
as FICA
Filing taxes involves reporting your earnings for the
year on a tax return.
This is sent to the IRS and to any appropriate state
or local tax collection agency

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 Summary

Tax planning is another important step in

your financial plan
Taking full advantage of the ways to reduce
your taxable income takes planning

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 Key Terms and Vocabulary

Adjusted gross income Net pay

Capital gain Payroll tax
Gross income Personal income tax
Gross pay Sales tax
Internal Revenue Service Social security
(IRS) Standard deduction
Itemized deduction Take-home pay
Medicare Tax
Tax return

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 Websites

www.irs.gov
www.taxadmin.org/fta/rate/ind_inc.html

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