Chapter 4 Flashcards
Why do we have taxes?
to finance government activities
What fraction of each dollar earned goes toward taxes?
1/3 of each dollar earned goes to pay taxes
What are three general things to do when it comes to taxes?
know current tax laws as they affect you; maintain complete tax records; plan purchases and investments to reduce tax liability
What is tax planning?
taking advantage of tax benefits while paying the fair share of taxes
The top 1% of taxpayers pay what percentage of all taxes?
38.1%
The top 5% of taxpayers pay what percentage of all taxes?
next 20.9%
The top 10% of taxpayers pay what percentage of all taxes?
next 11.2%
The top 25% of taxpayers pay what percentage of all taxes?
next 16.2%
Overall, the top 25% of taxpayers pay what percentage of taxes?
86%
Define sales tax
added to purchase price of product
Define excise tax
imposed on select G&S (e.g. gas, cigarettes, alcohol, tires, airfare, etc.)
Define ad valorem.
tax based on the assessed value of an item such as real estate or personal property
Define real estate property tax.
ad valorem
Define personal property tax.
imposed on personal property (e.g. cars, boats, furniture)
What are the four main types of taxes?
taxes on purchases, taxes on property, taxes on wealth, taxes on earnings
What is the federal estate tax?
paid by decedent and imposed on value of decedent’s property as of date of death or alt. valuation date, if estate > $11,180,000
What is the gift tax?
paid by donor on gifts > $18,000
What is the state inheritance tax?
paid by donee and levied on value of decedent’s property bequeathed to donee
What is the income tax?
tax on income levied at both the state and federal levels
Which 9 states do not levy income tax?
TX, WA, FL, NV, AK, SD, TN, NH and WY
What is the Social Security tax?
on wages of $128,400 (2018) to finance OASDHI benefits of SS program
What is taxable income?
net income, after deductions, on which income tax is computed
What is step 1 in computing your tax liability?
Determining adjusted gross income (AGI)
What are four types of taxable income?
earned income, investment income, passive income, other income
What is earned income?
includes wages, salary, commissions, fees, tips or bonuses
What is investment income?
(a.k.a., portfolio income) money from dividends, interest, or rent from investments
What is passive income?
from business activities -you do not directly participate -limited partnership
What is other income?
includes alimony, awards, lottery winnings, and prizes
Total income is affected by
exclusions
(T/F) Exclusions are included in gross income.
False, they are NOT included in gross income.
Give three examples of exclusions.
Gifts (less than or equal to $15,000 for 2018); employer-paid health premiums; earned foreign income (less than or equal to $104,100 for 2018)
What is tax-exempt income?
income not subject to federal income tax (e.g. interest on most municipal bonds)
What is tax-deferred income?
income that will be taxed at a later date
Give an example of tax-deferred income?
earnings from a traditional IRA
What is adjusted gross income?
gross income after certain “adjustments to income” have been made
Give four examples of adjustments to gross income.
contributions to a traditional IRA; alimony payments; student loan interest/tuition/fee deductions; tax-deferred retirement plan contributions such as a 401(k) or a 403(b)(7) tax shelter
What is step 2 in computing your tax liability?
computing taxable income
What is a tax deduction?
an amount subtracted from AGI to arrive at taxable income
How do you compute the tax deduction?
Either subtract the “standard deduction” from AGI on
Form 1040 or “itemize” your deductions on Sch. A
What is a standard deduction?
set amount on which no tax is paid
What are the standard deductions for 2018?
$12,000 if filing as single or married separately; $24,000 if filing as qualifying widow or married jointly; $18,000 if filing as head of household
What are itemized deductions?
expenses the taxpayer can deduct from the AGI
Give 5 examples of itemized deductions.
medical, dental expenses (7.5% of AGI); state/local taxes along with mortgage interest, contributions, and charitable deductions; certain job and misc. expenses ( > 2% of AGI); certain casualty and theft losses ( > 10% of AGI); certain moving expenses, if moving > 50 miles
What is the next step, after determining your tax deductions? (2)
subtract your exemptions from the AGI; a deduction for yourself, your spouse, and your qualified dependents
How much are the exemptions for 2017?
$4,050 per person in 2017
After determining the tax deductions and exemptions, what’s the next step?
determining tax rates and tax credits
What is the basis for the amount of your income tax?
taxable income
In the chart, which four scenarios have taxable income?
lottery winnings; bartering income; mileage for driving to volunteer work; income tax preparation fee
What is step 3 in computing your tax liability?
calculating taxes owed
What is the marginal tax rate?
rate used to calculate tax on the last dollar of taxable income
What are the 7 marginal tax rates for 2018?
10, 12, 22, 24, 32, 35, and 37%
What is the average tax rate?
based on the total tax due and taxable income
How do we calculate the average tax rate?
tax liability / taxable income
What is true about the ATR and the MTR?
ATR < MTR
Define tax credit.
an amount subtracted directly from the amount of taxes owed (e.g., the earned income, child, and dependent care credits)
What’s the difference between a tax credit and a tax deduction?
tax credit is a flat amount, whereas tax deduction is a percentage; tax credit is much better than a tax deduction
Give 8 examples of recent tax credits.
foreign tax; child and dependent care; adoption expenses; American Opportunity/Lifetime Learning (college expenses); earned income tax credit; energy savings; elderly and disabled; Obamacare premium credit
(T/F) All taxes are paid by April 15.
False, not all of them are paid by April 15.
How do the self-employed pay taxes?
pay quarterly estimated taxes, on the 15th of April, June, September, and January
Which form tells employers how much to withhold for taxes?
Form W-4
Low-income workers may
file for an exemption from withholding if no tax liability is expected
What is the tax filing date for individuals?
April 15
What is Form 4868?
used as an extension to file, but not to pay taxes
What is Form W-2?
reports your annual earnings and deductions for taxes and social security
How many filing status categories are there?
5
What are the five filing status categories?
single/legally separated; married, filing jointly; married, filing separately; head of household; qualifying widow/widower (2 years)
What is the head of household status?
unmarried individual who maintains a household for a child or dependent relative
If single, under 65 with an income under $12,000, do you have to file?
no
Which is the least complicated tax form?
1040EZ
What are the stipulations for using Form 1040EZ? (6)
single or married filing jointly; under age 65; no dependents; no more than $1,500 of taxable interest; taxable income less than $100,000; no itemized deductions, adjustments, or tax credits
What are the stipulations for using Form 1040A? (4)
taxable income less than $100,000; adjustments allowed; tax credits for child/dependent care allowed; IRA deduction allowed
What are the stipulations for Form 1040? (2)
required to use 1040 if income is over $100,000; useful for itemizing deductions
What are the stipulations for Form 1040X?
used to amend a previously filed return
What is the overall, 9-step process for calculating taxes?
filing status and exemptions; income; adjustments to income; tax computation; tax credits; other taxes; payments; determine if you’re due for a refund or owe taxes; sign your return
How do you file taxes by phone?
using Telefile (only if using Form 1040EZ)
What is Free File Alliance?
offers free tax prep and e-filing for some taxpayers
(T/F) If a professional tax preparer makes a mistake, you’re not responsible.
False, you’re still responsible for paying the correct amount
What percent of tax returns is audited?
1.3%
What are the four types of audits?
correspondence audit; office audit; field audit; research audit
What is a correspondence audit?
for minor questions
What is an office audit?
takes place at an IRS office
What is a field audit?
complex, with an IRS agent visiting your home, business or accountant’s office
What is a research audit?
line-by-line investigation of everything (not in text)
What is tax avoidance?
Legitimate methods to reduce your tax obligation to your fair share, but no more
What is tax evasion?
Illegally not paying all the taxes you owe, such as not reporting all income
What are four strategies to minimize taxes owed?
accelerate deductions (if you expect to have a lower tax rate next year); delay receipt of income (if lower tax rate next year); delay deductions (if higher tax rate next year); accelerate receipt of income (if higher tax rate next year)
What is a tax strategy for homeowners?
mortgage interest and property taxes are deductible when you itemize
What is a HELOC?
home equity line of credit; use it to buy a car or consolidate debt - the interest can be deductible when you itemize
Job-related non-reimbursed expenses
may be allowed as itemized deductions over 2% of AGI
Estate planning
gifts of up to $15,000 are not taxable to the donor or the donee
Tax-exempt investments
interest income from municipal bonds is not subject to federal income taxes
Tax-deferred investments (3)
Series EE US Treasury bonds interest is exempt, if used for tuition; tax-deferred annuities; tax-deferred retirement plans
Long-term capital gains
on the sale of a home are excluded from taxes up to $500,000 if filing married-jointly; otherwise $250,000
If held for more than one year, long-term capital gains are taxed at
15%
What are some self-employment tax strategies?
can deduct health/life insurance costs, but have to pay a self-employment tax
Children’s investments
and income shifting (< $2,100 and child under age 18)
Education IRA savings
earnings for college are tax-free, but deposits are not tax deductible
What is a traditional IRA?
tax-deferred contributions that can be withdrawn after age 59 ½ without 10% penalty
What is a Roth IRA?
after-tax contributions, but withdrawals tax-free after 5 years
What are qualified plans?
employer plans whereby employer deducts a portion of pre-tax wages from employees and contributions and earnings grow tax-deferred
What are non-qualified plans?
retirement plans not eligible for tax-deferred benefits, so deducted contributions are taxable
What are self-employed plans?
contribute into a tax-deferred retirement plan if IRS rules are followed (e.g., SEP)
