Chapter 4: Personal Taxation

Annual U.S. Federal Deficit

- $665 billion in 2017

Defendants No Nos

- A taxpayer cannot claim a dependent if he or she is listed as a dependent on someone else's tax return. - A dependent cannot be claimed on two different tax returns.

Adjusted Gross Income (AGI)

- Amount that is reported on Form 1040

Governments use taxes to:

- Build infrastructure - Provide social welfare - Pay for national defense - Provide other public services - Encourage economic activity

Special Standard deduction

- Exists for children claimed on their parents' tax return. The standard deduction for dependent children is equal to the greater of $1,050, or the sum of $350 plus the dependent child's earned income up to the standard deduction for single filing status ($12,000 in 2018).

Tax Burden

- Federal Income Tax - State and Local Taxes - Payroll Tax - Sales Tax - Property Tax

Types of Taxes

- Federal income taxes - State income taxes (where applicable) - Payroll taxes - Sales taxes -- Pay whenever a transaction occurs - Property taxes -- Paid just once or twice a year

Qualifying Relative

- He or she is not a qualifying child of another person. - His or her relationship to the taxpayer is that of child (as defined previously), parent, grandparent or direct ancestor, aunt, or uncle. - The relative has less than $4,150 (in 2018) of gross taxable income. - The taxpayer provides more than half the dependent's support.

Federal Surplus

- If tax revenue exceeds annual expenditures - decreases the U.S. debt

Congress encourage you to take actions

- Investing in your human capital (education). - Starting a business. - Buying a home. - Saving for your retirement. - Maintaining your health.

Excluded from Gross Income

- Loan proceeds. - Gifts and inheritances. - Scholarships (educational assistance) used for tuition, fees, and required books and supplies. - Capital gain on sale of primary residence (up to $250,000 for those who are single and $500,000 for those who are married). - Life insurance death benefits. - Fringe benefits through employment, such as health insurance premiums. - Qualifying distributions from Roth IRAs. - A portion of, or all, Social Security benefits. - Municipal bond interest.

Regressive Tax

- Low-income earners pay a larger proportion of their incomes in taxes to high-income households - percentage of income paid in taxes to decrease as income rises Example: Sales tax on food

Married Filing Separately

- Must be legally married on the last day of the tax year and choose to file separately

Married Filing Jointly

- Must be leggaly married on the last day of the year (December 31)

Head of Household

- Not married - Support at least one qualifying dependent

Single

- Not married - No dependent children or relatives

Options for how households should be taxed include the following:

- Predominantly high-income households should pay the most (progressive tax). - Households should pay in proportion to their income (flat tax). - Everyone should pay the same amount regardless of their income (regressive tax).

Short-Term Capital Gains

- Short-term capital gains result from selling a capital asset at a gain, but the asset is owned for one year or less. Short-term capital gains are taxed as ordinary income and do not receive any special tax treatment.

Qualifying Widow(er)

- Spouse died within 3 previous years and has not remarried - Support at least one qualifying child - In the year of death, surviving spouse files as married filing jointly or married filing separately.

U.S. Debt

- The amount of money the U.S. has borrowed and must repay - In 2018, total U.S. debt was more than $20 trillion.

Progressive tax

- Those with more income pay increasingly higher taxes - High-income earners pay a disproportionately larger amount of taxes. - High-income households having higher tax rates applies to their tax base - Lower-income households having lower tax rates applied to their tax base - are not constant and increase with income - lowest federal tax rate in U.S. ~ 10% - Highest rate is 37%

Capital Losses

- Unfortunately, you may not always sell investments for a gain. Hopefully, though, only on rare occasions will you sell an asset for less than you paid for it and create a capital loss. Capital losses first offset any similar capital gains that you have. After that, $3,000 of capital losses can be reported on your tax return, which can reduce your tax base.

Gross income is the sum of

- Wages and salary from work. - Income from self-employment, partnerships, and so forth. - Interest, dividends, capital gains, and rents. - Scholarships and grants in excess of tuition and books. - Unemployment benefits and bartering. - Alimony received. Pensions and retirement plan distributions.

Tax Return Process

- You must file a federal income tax return if your income is above a certain level, which varies depending on your filing status, age, and the type of income you receive. - Thus, if you have income and tax withholdings, it is important to file a tax return because it is more than likely the IRS already knows about your income. - Even if you owe no tax and are not required to file a tax return, it is always an excellent idea to file a tax return because you can claim a refund for any taxes that were withheld from your paycheck.

Internal Revenue Service (IRS)

- a government agency within the U.S. Department of the Treasury that is charged with collecting taxes and enforcing tax laws passed by Congress - The IRS can impose many penalties on individuals who fail to comply with the law. - The most common penalties are associated with the failure to file a tax return and the failure to pay a tax penalty. These penalties can add up to 25% of any tax owed. - Additional penalties can be assessed for fraudulent tax reporting. - If penalties are assessed, a taxpayer may also have to pay interest on the unpaid taxes, with interest accruing from the date the taxes were originally due.

Tax Bracket

- a predefined range of taxable income in which a single tax rate applies. - build on one another to create a continuous scale of seven different tax rates, ranging from 10% to 37%, that are applied in a progressive manner to calculate a taxpayer's income tax.

Form w-4

- allows and employee to increase of decrease the amount of tax liability at the end of the year

Standard deductions

- an amount set by Congress and increases each year based on a modified measure of inflation - determines by your filling status - An additional deduction is available for those age 65 or older or blind.

Itemized deductions

- are specific expenditures that taxpayers can claim instead of the standard deduction. Include: - State and local taxes, including property and income tax (capped at $10,000). - Out-of-pocket medical expenses that are more than 7.5% of the taxpayer's AGI (in 2018). In 2019, medical expenses must exceed 10% of AGI to be deductible. - Interest paid on mortgage debt associated with your primary home (deductible interest limited to mortgage debt of $750,000 or less). - Donations to charities.

Qualifying children

- considered dependents of the taxpayer Must pass 4 general tests: 1. Support - The child did not provide more than half of his or her own support during the tax year. 2. Age - At the end of the tax year, the child was: - Younger than 19 and younger than the taxpayers OR - A full-time student, younger than 24, and younger than the taxpayer 3. Relationship - Taxpayer's child, adopted child, stepchild, foster child, or his or her descendant OR - Taxpayer's sibling, half-sibling, step-sibling, or descendant of any of them. 4. Abode - The child must live with the taxpayer for more than half the year, excluding temporary absences such as schooling, vacations, and illness.

Filling status

- determine by your martial status and the presence of dependents. Two categories of dependents: 1. Qualifying children 2. Qualifying relatives

Federal Income Tax Withholdings

- determined on Form W-4, which an employee fills out with her or his employer

Federal Deficit

- he amount of which annual federal government expenditures exceed annual federal receipts, which are made up primarily of tax collections. - adds to the U.S. debt

Capital Gain Income

- included in gross income, but a different tax rate applies to long-term capital gains and qualified dividends

Ordinary Income

- income derived from work, interest, self-employment, retirement plan distributions, rents, royalties, and other sources of earned income.

Tax Return

- information that a taxpayers complies and reports to the IRS on a standardized form.

Property Tax

- is assessed based on the value of property that you own, such as your car or your home. - vary by state and are mostly assessed by the city or county - imposed annually on the value of your vehicle and are often referred to as ad valorem taxes - tax base determined by current assessed value of property - tax rate determined by each taxing authority

Ad Valorem Taxes

- means "according to value" - help to fund local roads, schools, and community improvements

Effective Tax Rates

- measures the average tax an individual pays on his or her entire income ETR = [ Total Federal Taxes/ Taxpayer's Total Income] x 100 - A taxpayer's effective tax rate will always be less than the taxpayer's marginal tax rate and tax bracket tax rate because of the progressive structure of the U.S. tax code. - The married-filing-jointly taxpayer has tax of $5,739, resulting in an effective tax rate of 7.7% [($5,739 ÷ $75,000) × 100]. - The single taxpayer's tax is $9,799.50, resulting in an effective tax rate of 13.1% [($9,799.50 ÷ $75,000) × 100].

Sales Taxes

- not deducted from your pay - imposed by state and local governments on the sale of certain goods and services - help local community pay for police and fire departments, schools, and public services

FROM AGI deductions

- not used to calculate AGI but do further reduce AGI. When claiming FROM AGI deductions, taxpayers can either claim the standard deduction (available to all taxpayers) or itemize their deductions

Kiddie Tax

- on dependent children with more than $2,100 (in 2018) of unearned income, such as interest and dividends - with more than $2,100 (in 2018) - applies to dependent children until the year they reach age 25. - ensures that a child's excess unearned income will be taxed at a higher tax rate.

Long-term capital gains

- produced by selling assets (such as real estate or stock) that you have owned for more than 1 year for a profit. -most commonly taxed at 0% or 15%, with an exception for higher-income households - If you have a $1,000 long-term capital gain from selling an investment and you are single with taxable income of $35,000, your tax rate on the capital gain will be 0%! - If you are single and your taxable income is between $38,600 and $425,800, then your tax rate on long-term capital gains will be 15%. - If you are single and your taxable income is above $425,800, then your long-term capital gains tax rate will be 20%. For example, your tax on a $1,000 gain will be $200.

Not claiming allowances

- results in having more money withheld from her pay for income taxes

Tax System

- s systematic and consistently applied method determining how much tax an individual must pay

Deductions

- specific expenses allowed by Congress that can be used to offset gross income - generally capped Types: 1. FOR AGI deductions which are used to calculate AGI 2. FROM AGI deductions which reduce AGI further to calculate taxable income

Flat Tax

- systems impose the same tax rate on all taxpayers subject to the tax - everyone pays the same tax rate - Everyone shares the tax burden in proportion to his or her income. - Russia, Ukraine, Estonia, and Latvia have a flat tax system - Russia is 13% and Latvia has 25%

Withholdings

- taxes taken out of an employee's pay by the employer - some maintained by law - other are elected by employees Includes: - federal and state income taxes and payroll taxes, as well as employee benefits and charitable contributions

Taxable Income

- the amount remaining after the standard deduction or itemized deductions. - is your tax base that will be used to determine your income tax. - Your income does not equal your taxable income (tax base)

FOR AGI deductions

- the first dollar of qualifying expenses immediately begins lowering your gross income and consequently your taxable income - common example is interest paid on student loans Examples of FOR AGI deductions include: - Contributions to a Health Savings Account (contribution limit for a single individual is $3,450 in 2018). - Contributions to a traditional IRA (contribution limit is $5,500) and contributions to other self-employed retirement plans. - Health insurance premiums paid by self-employed individuals.

Marginal Tax Rate

- the rate of change in tax resulting from a change in income or deduction. MTR = [ New Tax Liability - Old Tax Liability/ New Income - Old Income] To calculate the marginal tax rate, you will need to know: - The new tax liability after the change in income. - The old tax liability before the change in income. - The change in income.

Gross Pay

- the total amount an employee earns before taxes and other deductions are considered

Capital Assets

- things that you own for investment or personal use, either tangible or intangible, such as stocks, mutual funds, coin collections, other investments, personal belongings, cars, and real estate. - are defined by the IRS by what they are not. - They are not used in your business (such as a tablet or a car). - They are not a result of your normal business activities (like accounts receivable at a business). - They are not associated with creative works (e.g., copyrights of songs and movies) of the people who created them.

Five Filling Statuses

1. If you are unmarried and are not the primary provider for a dependent child, then your filing status is single. 2. If you are married, you can choose whether to file jointly or separately. Marital status is determined as of December 31. Generally, filing as married filing jointly results in a lower tax liability. 3. However, you may want to file married filing separately in some situations, like when one spouse has significant medical expenses or if the spouses do not want to combine their tax records. 4. If you are unmarried and you are the primary provider of a qualifying dependent, you should file as head of household. 5. If your spouse died within the past 3 years and you are continuing to care for dependent children, you may be able to file as a qualifying widow(er) with dependent children, depending on the circumstances. In the year of death, the filing status is either married filing jointly or married filing separately.

3 important rules to remember about these assets:

1. If you were to sell any of these items for more than you paid for them, you would have a taxable capital gain. If you owned the items for more than a year, then long-term capital gains tax rates (discussed in the next section) would apply. 2. If you sold a personal-use item for less than you paid for it, could you deduct it as a capital loss on your tax return? No. Unfortunately, you cannot report a loss on personal use items; you can only report the gain. 3. A special category of long-term capital assets called collectibles is taxed at 28%. Collectibles include items like artwork, stamps, coins, and antiques.

Sales taxes determined by:

1. Tax Base: the amount of money that will be taxed, which is generally based on the cost of the item you purchase 2. Tax Rate: used to calculate the amount of tax owed, which is generally denoted as a percentage rate, such as 7.5% Tax Base x Tax Rate = Tax

Breakdown of Federal Tax Revenue

49% Individual income tax 33% FICA 9% Corporate Tax 9% Other tax

Symbols and Meanings

Gross Income - Deduction for adjusted gross income = Adjusted gross income - Deductions from adjusted gross income = taxable income (tax base) x Tax rate(s) multipled by taxable income = Assessed income tax + Other taxes and penalties - Credits and withholdings = Net tax due (or refund)

Federal Insurance Contributions Act (FICA) or Payroll Taxes

Tax which is used exclusively to pay for two government programs: 1. Social Security (FICA Old Age, Survivor, and Disability Insurance [OSADI]). This applies to earned income up to $128,400 (in 2018). 2. Medicare (FICA health insurance [HI]). This applies to all earned income. - expect to pay 7.65% of your gross pay for Social Security and Medicare - help fund retirements benefits and health insurance for current retirees

Taxes

financial obligations imposed on individuals and businesses by government entities.