Download Chapter 7 Federal Income Tax

Chapter
7
Federal Income Tax
7.1 Our Tax System
7.2 Filing Tax Returns
© 2010 South-Western, Cengage Learning
Lesson 7.1
Our Tax System
GOALS
Explain the purpose of taxes and
describe the different types of taxes.
Describe the U.S. tax system and explain
how it works.
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Purpose of Taxes
In a free enterprise system such as ours,
the government collects money from
citizens and businesses in the form of
taxes.
These incoming funds to the government
are called revenue.
The government spends the revenues
received according to priorities set by
Congress.
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Types of Taxes
Progressive taxes
Regressive taxes
Proportional taxes
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Progressive Taxes
Progressive taxes take a larger share of
income as the amount of income grows.
Federal income taxes are progressive.
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Regressive Taxes
Regressive taxes take a smaller share
of income as the amount of income
grows.
Sales taxes are regressive.
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Proportional Taxes
Proportional taxes, or flat taxes, are
taxes for which the rate stays the same,
regardless of income.
Property taxes are proportional.
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Components of the Tax System
The IRS
The power to tax
Paying your fair share
Tax rates apply to income ranges, or tax
brackets.
Our income tax system is based on
voluntary compliance, which means that
all citizens are expected to prepare and file
tax returns of their own accord without force.
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(continued)
Components of the Tax System
Failure to pay taxes
Failure to do so can result in a penalty:
interest charges on the taxes owed plus a
possible fine.
Willful failure to pay taxes is called tax
evasion, which is a serious crime
punishable by a fine, imprisonment, or both.
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An IRS Audit
Every year, the IRS calls millions of
taxpayers for an audit, which is an
examination of their tax returns.
Types of audits
Office audit
Correspondence audit
Field audit
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Lesson 7.2
Filing Tax Returns
GOALS
Define basic tax terminology.
Prepare tax forms 1040EZ and 1040A.
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Filing Status
Filing status describes your tax-filing
group.
You must mark one of the following as
your filing status on your tax form:
Single person (not married)
Married person filing a joint return
Married person filing a separate return
“Head of household”
Qualifying widow(er)
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Exemptions
An exemption is an amount you may
subtract from your income for each
person who depends on your income to
live.
Each exemption reduces your taxable
income and thus your total tax.
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Exemptions—Who Qualifies
Yourself, unless someone else claims
you on their return
Your spouse, if you are filing jointly
Your dependents
A dependent is a person who lives with you
and for whom you pay more than half his or
her living expenses.
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Gross Income
Gross income is all the taxable income
you receive.
Earned income refers to money you
earned from working.
Unearned income refers to money you
received from passive activity (other than
working).
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Common Types of Income
Wages, salaries, and tips
Interest income
Dividend income
Unemployment compensation
Social security benefits
Child support
Alimony
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Gross Income
Earned Income
Unearned Income
Non-Taxable Income
Wages
Interest
Child support
Salaries
Dividends
Gifts
Tips
Alimony
Inheritances
Unempl. Compensation
Life ins. Benefits
Worker’s Comp. Ben.
Veteran’s benefits
Scholarships / grants
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Adjusted Gross Income
 The law allows you to subtract some types of
spending from gross income.
 You can “adjust” your income by subtracting such
things as contributions to individual retirement
accounts, student loan interest, and tuition and fees.
 These adjustments are subtracted from gross
income to determine adjusted gross income.
 Adjustments reduce income that is subject to tax.
 Note that these adjustments are not available on
Form 1040EZ.
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Adjusted Gross Income
Gross income
– Adjustments
Adjusted gross income
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Taxable Income
Taxable income is the income on which
you will pay tax.
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(continued)
Taxable Income
Gross income
– Adjustments
Adjusted gross income
– Deductions
– Exemptions
Taxable income
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Deductions
Itemize deductions
Standard deduction
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Itemize Deductions
 Itemize deductions are expenses you can subtract
from adjusted gross income to determine your taxable
income.
 Examples include:
 Medical and dental expenses beyond a specified percentage
of your income
 State and local income taxes
 Property taxes
 Home mortgage interest
 Gifts to charity
 Losses from theft or property damage
 Moving expenses
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Standard Deduction
If you do not have many deductions, your
tax may be less if you take the standard
deduction.
The standard deduction is a stated
amount that you may subtract from
adjusted gross income instead of
itemizing your deductions.
This amount changes each year.
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Tax Credits
 A tax credit is an amount subtracted directly
from the tax owed.
 It is different from a deduction.
 A deduction is subtracted from adjusted gross income.
 It reduces your tax by reducing the amount of income on
which the tax is figured.
 A tax credit reduces the tax itself.
 The government allows tax credits for certain
education expenses, child-care expenses, and
other reasons from time to time.
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Preparing Your Income Tax Return
Who must file?
When to file?
Which form to use?
Where to begin?
Filing electronically
Tax preparation software
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Form 1040EZ
Step 1: Name, address, and Social
Security number
Step 2: Report income
Step 3: Compute tax
Step 4: Refund or amount owed
Step 5: Sign the return
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Form 1040A
 Step 1: Name and address
 Step 2: Filing status
 Step 3: Exemptions
 Step 4: Income
 Step 5: Adjusted gross income
 Step 6: Taxable income
 Step 7: Tax, credits, and payments
 Step 8: Refund or amount owed
 Step 9: Signature
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