Joe Sulock, University of North Carolina at Asheville

Reality Math

Joe Sulock, University of North Carolina at Asheville

Dot Sulock, University of North Carolina at Asheville

Income Taxes I

1. Social Insurance Taxes

Taxes can be a maddeningly complex topic. For starters, there are lots of different taxes. You buy a shirt and you pay a sales tax. You buy a tire and you pay an excise tax. You buy a house and you will pay a property tax. You take a job and you will likely pay social security and income taxes on the money you earn. These income taxes are the focus of this unit.

Social Insurance Taxes are mainly used to finance two major programs: Social Security and Medicare. The former provides retirement benefits for the elderly, and the latter provides medical assistance. These taxes are about 7.5% of the gross income you earn. If you earn $30,000 per year, your social insurance taxes will equal $2,250. These taxes are taken out of your paycheck before you receive it.

1. If you earn the federal minimum wage of $7.25/hr and work 40 hours a week for 50 weeks a year

(a) how much would you make per year?

(b) About how much will your social insurance taxes be each year?

2. “Taxable Income” for Federal Income Tax

Federal Income Taxes can be a very complicated but in many cases are actually very simple. Filing your own federal income tax forms can save you hundreds of dollars.

A. First you need to know you “filing status.” For most of us, we will file as a “single” or as “married, filing jointly.” Other options are not covered in this unit.

B. Second, you need to determine how much of your income is “taxable.”

Taxable Income = Gross Income minus Exemptions minus Deductions

Exemptions: $3,950 for each person including dependent children

Standard deductions: $6,200 for a single person

$12,400 for married couple filing jointly

A single young worker will probably take the “standard deduction” so he or she will not have to pay taxes on $6,200 + $3,950 = $10,150 of income.

Some would pay lower taxes if they “itemized deductions.” Itemizable deductions would be charitable contributions, interest on a mortgage, medical expenses above a certain amount, state income tax, property taxes, and other things beyond the scope of our unit.

A tax-filer cannot both itemize deductions and take the standard deduction!

The tax-filer must chose between these two options, choosing to deduct the largest possible amount from his or her income to get the lowest possible taxable income.

C. Third, you need to compute what tax you must pay on your taxable income or look up this tax in the federal tax tables.

D. Lastly, you must know how much federal income tax your employer has already paid for you out of your paychecks. This will be reported to you in January on a W-2 form from your employer.

Example: Single person with no dependents

Eliza is one year out of college, earns $30,000 per year, and is single with no dependents. Eliza has one exemption, herself, so her personal exemption is $3,950.

Eliza’s taxable income = $30,000 - $3,950 (personal exemption) – $6,200 (standard deduction) = $19,850

3. Finding Federal Income Tax due from tax table.

Putting 2014 tax tables into Google, wefind the 2014 income tax for her taxable income of $19,850 to be $2,520.

2. Gloria is single and makes the New York minimum wage of $9/hour, working 40 hours a week for 52 weeks a year. Determine her

(a) annual gross income

(b) annual social insurance taxes

(d) annual federal taxes

(e) approximate annual “take-home pay” after social insurance taxes and federal taxes

(f) approximate weekly “take-home” pay

Social insurance taxes are taken directly out of your salary. Income tax is harder to figure, so your employer tries to “withhold” about the right amount each week. The employer sends your “withholding” to the IRS where they put it into your tax account. When you file yourtaxes they give you back any excess in this account as a tax refund or you may owe them money if the “withholding” was not enough.

3. In which case will Gloria get an income tax refund?

(a) employer withholds too much or employer does not withhold enough

(b) Would you prefer to have too much or too little withheld?

4. Print out two 1040EZ forms and fill it them out for Eliza. On line 11 check Full-year coverage and leave line 11 blank. Assume that her employer sent her a W-2 form reporting income tax withholding of

(a) $3,254 for the first form

(b) $2,435 for the second form.

5. Antonio is single and makes $12/hr, 40 hours a week, 52 weeks a year. He has $1000 in itemizable deductions for federal tax purposes.

(a) Determine his gross annual income.

(b) Determine his taxable income for federal income taxes.

(d) About how much should his employer be withholding from his paycheck for federal income taxes each week?

6. Jade makes $50,000 annually and is paid monthly. She is single and contributes 10% of her salary to her church every year but has no other itemizable deductions. (a) Determine her taxable income

(b) Use the 2014 federal tax tables to find the federal income taxes due.

4. One Complexity a Recent Graduate Will Want to Understand!

We mentioned that the Federal tax code is quite complex and the purpose of this unit is to provide the “big picture” of how it works. Still, there is one complexity that recent graduates should be aware of since it could save them hundreds of dollars. Let’s return to Eliza, our recent graduate, who makes $30,000 in her first job. After subtracting her “exemption” and the “standard deduction,” her taxable income was $20,000 and she paid federal income taxes of $2,554.

But suppose like many students she had taken out a student loan to help pay her way through college. The interest she pays on that loan could be eligible for what some call an above-the-line tax deduction. Let’s suppose she paid $1,500 of interest on such a loan. The IRS may allow her to deduct this $1,500 from her gross income and still take both her exemption and her standard deduction.

$30,000 - $3,950 (exemption) - $6,200 (standard deduction) - $1,500 (student loan interest)

If so, her taxable income will fall to $18,350.

7. If Jade, from problem 6, is eligible for an above-the-line deduction of $1,000 interest on a student loan even though she takes the standard deduction, how much will she save in taxes?Note the underlined words in the previous paragraph. She may not be eligible and must consult IRS Publication 970 ( to get all the details. If she is eligible for the student loan interest deduction, it could save her money on her state income taxes also, since many states use federal taxable income to determine state income taxes.

8. Reflect. Namethe biggest five slices of federal income tax spending from biggest to smaller.