Chapter

7
Federal Income Tax

7.1 Our Tax System

7.2 Filing Tax Returns

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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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