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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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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