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Chapter 6
Paying Taxes
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Math for Personal Finance
• Ryan’s take-home or net pay was $147.76 and his gross pay
was $160.00. Assume the FICA withholdings are 7.65. How
much did Ryan pay in FICA from this check?
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Math for Personal Finance
• Solution: Solution: Ryan paid 7.65 percent of
the $60 or $12.24 in FICA from this check.
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Math for Personal Finance
• Brogan’s grandfather made $112,000 in 2007, and the
Social Security cap in 2007 was $97,5000. How much
Social Security was withheld from his pay and how much
Medicare was withheld from his pay?
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Math for Personal Finance
• Solution: Brogran’s grandfather had 6.2%
withheld from his pay for the first $97,500
he made during 2007 for a total of $6,045 or
(.062 x $97,500). However, Medicare was
withheld on the entire amount so Medicare
withholdings were $112,000 x .0145 =
$1,624.
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Math for Personal Finance
• Last year Colt’s salary was $32,000 but he also received
$1,200 in dividend income and lost $400 on the sale of one
stock and gained $650 on the sale of another stock. What
was Colt’s gross income?
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Math for Personal Finance
• Solution: Colt’s gross income was $32,000 +
$1,200 - $400 +$650 = $33,450
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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
•
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•
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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
on purchases at
a store
• Some of the price we pay for an
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
• Payroll Taxes are
taxes on your
paycheck
• Many people pay taxes every time
they get paid
• 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
service (IRS) is the
government body that
carries out the federal
tax system
• The IRS is a branch of the
United States Treasury
Department
• 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
to the IRS all the
information relative
to your income
taxes
• A tax return consists of a form
called 1040 or 1040EZ (see Figure
6.2 a &b)
• 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
federal income taxes and state
income taxes (the states that
have them)
• Social Security provides
payments to eligible retirees and
disabled people
• Medicare provides health care
coverage to mostly older
Americans and some younger
disabled people
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• Payroll taxes include:
– Social Security and
Medicare taxes
– Personal income
taxes (state and
federal)
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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 salary—up 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 total income
consisting of the
total amount of a
person’s income
from (almost)
any source
• The first step in calculating the
federal tax you owe is to determine
your gross income
• Your employer will send you a W-2
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
• Capital gains occur
when you sell an asset
for more than what
you paid for it
• Other forms of income include
interest income, dividend income,
and capital gains
• Gross income also includes income
from 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
– Veteran’s welfare benefits
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Adjusted Gross Income
• Adjusted gross
income is figured by
taking the total
income and
subtracting certain
allowable amounts
• The next step in filing a tax
return is to figure your adjusted
gross income, or AGI.
• The allowable amounts include :
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– contributions to certain retirement
accounts
– alimony payments
– interest paid on student loans
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Deductions and Exemptions
• Standard deduction is a
fixed amount all people
are allowed to deduct
from their AGI to reduce
their tax liability
• Itemized deductions are
specific expenses that,
under tax law, can be
deducted from income to
reduce the amount of
income subject to income
tax
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• You may be able to claim
various deductions and
exemptions that will reduce
the amount of your AGI that
is subject to your income
taxes.
• These deductions include:
– Standard deduction
– Itemized deduction
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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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