Understanding Taxes

1. Understanding Taxes 2010 Personal Finance Institutes EPF Standard 16

2. Course Instructional Materials Developed By: Virginia Department of Taxation School Outreach Program

3. Introduction • Taxes provide revenue for federal, state and local governments to fund essential services provided to its residents. • As citizens want more services from government agencies, the amount of funds needed also increases. • Funds are collected by the government through the taxation of its citizens. • Each level of government makes its own decisions about how and what to tax, as well as how to spend the money. Although most federal revenue comes from income taxes, state and local revenues may come from income taxes, transaction taxes such as sales tax and property tax. • Other sources of revenue, not categorized as taxes, include user fees, fines and borrowing.

4. Objectives After completing this lesson you will be able to: • Identify types and purposes of taxes • Identify three tax structures • Identify how a budget is reached • Differentiate between tax exemptions, deductions and credits • Identify sources of federal, state and local revenue • Identify some of the ways tax funds are used by different levels of government

5. Where Does Your Money Go? Federal, State and Local governments use tax funds to provide services to the general populace. Tax funds from all 3 branches of government are used to fund services for:

6. Schools

7. Parks

8. Roads and Highways

9. Law Enforcement

10. Where Does Your Money Go… There are some services that are provided by each branch of government separately.

11. Where Does Your Money Go... Federal government also uses tax revenue to provide services such as: • National Defense • Monitoring and regulating trade and the economy • Healthcare • Social Services • Job Training • Unemployment Benefits • Welfare Programs

12. Where Does Your Money Go... State government also uses revenue funds to provide services such as: • Healthcare • Transportation • Welfare programs • Unemployment benefits • Monitoring and regulating state government

13. Where Does Your Money Go... Local governments also use tax revenue to provide services such as: • Libraries • Transportation

14. Where Does Your Money Go ... Virginia has a biennial (two-year) budget system that is created through 5 phases:

15. Where Does Your Money Go ... For budgeting purposes, state revenues are divided into two broad types: • General fund • Nongeneral fund

16. Where Does Your Money Go ...

17. Where Does Your Money Go… 2008-2010 (General Fund Operating) = $34.5 Billion* *Chart represents the state of Virginia *2008 Virginia Acts of Assembly, Chapter 879

18. Where Does Your Money Go… Education funds for the operating general fund for 2008-2010* *Chart represents the state of Virginia Created by the Virginia Department of Taxation, School Outreach Project

19. Where Does Your Money Go… Expenditures reported for the year of 2009 for the City of Richmond. Created by the Virginia Department of Taxation, School Outreach Project

20. Tax Revenue Sources While there are many types of taxes collected within Virginia, there are two types that bring in the majority of the revenue collected. Those are: • Individual Income • Sales and Use Tax

21. Tax Revenue Sources… Virginia General fund in fiscal year 2009 revenue collected Created by the Virginia Department of Taxation, School Outreach Project

22. Taxes Fall Into 3 Tax Structures: • Progressive Tax • Proportional / Flat Tax • Regressive Tax

23. Progressive Tax Progressive Tax is a system in which the tax rate increases as the taxpayer’s income increases. As a result, a larger percentage of income is taken from high-income groups than from low-income groups.

24. Proportional Tax Proportional or flat tax is a tax rate that stays the same for everyone, regardless of their income level. For example, low-, middle- and high-income taxpayers would all pay a fixed tax rate of 5% of their income.

25. Regressive Tax A tax is considered regressive when taxpayers who earn lower incomes pay a higher percentage of their income than those who have a higher income. Sales tax is a regressive tax. Although the same tax rate (5%) is paid regardless of income level, it causes lower-income taxpayers to pay a larger share of their income than wealthier people pay.

26. Regressive Tax… Social security is collected at the same percentage from all, up to a certain income limit; above that no social security tax is collected. Thus, up to that limit, the tax is proportional; above the limit it is regressive because people earning more than the limit are paying a smaller percentage of their income in taxes than people below the limit.

27. Tax Types There are three types of taxes: • Federal • State • Local

28. Federal Taxes Include: • Individual Income Tax • Social Security / FICA • Corporate Income Tax

29. Virginia Taxes Include: • Individual Income Tax • Sales Tax • Corporate Income Tax

30. Local Taxes Include: In Virginia, localities can only tax what the state government allows them to tax. Some common local taxes include: • Real Estate Tax • Personal Property Tax • Meals Tax • Hotel Tax • Business License Tax

31. Activity and Lesson

32. Individual Income Tax • Individual income tax is a progressive tax. • Individual income taxes are levied by federal government and, in some cases, state and local government. • In Virginia, state government levies an income tax, but local governments are not authorized to do so. • Much of the information needed for income taxes is provided on a W-2 form.

33. Individual Income Tax… What is a W-2? • A W-2 form is an end-of-the year summary of a taxpayer’s gross income and withholdings. • Withholdings are paid by the taxpayer/employee and collected by the employer.

34. Individual Income Tax… Where and when can I get a W-2? • A W-2 is issued by employers and should be received by the employee/taxpayer by the beginning of February the following year. • For example, if you worked in 2009, your 2009 W-2 should have been received by February 1, 2010.

35. Individual Income Tax… Total Wages Earned Federal Taxes Paid Social Security/ FICA Taxing State State Taxes Paid

36. Individual Income Tax… Why do I need a W-2? • A W-2 form is required by the federal and state tax agencies when individuals file their income tax returns. • The federal income tax return is due, every year, by April 15th. • The income tax return for Virginia is due every year, by May 1st. • Virginia is one of the few states where the state return is not due on the same date as the federal return.

37. Sales and Use Tax… • Sales tax is a proportional and regressive tax. • In Virginia, sales taxes are paid to both the state and local governments. • The general sales tax rate in Virginia is 5%. The rate is comprised of a 4% state tax and a 1% local tax.

38. Sales and Use Tax… • Sales taxes are paid by the consumer of the goods purchased, but they are collected by the seller who makes the sale. The seller is responsible for remitting the sales tax collected to the state. • The state sends the local tax collected from the businesses within that locality to the local government. • For example, if you purchase a shirt from a retailer in the City of Richmond for $20.00, the total sales tax amount would be $1.00 (5% of $20.00). Of that $0.80 would be due to the state (Virginia) and $0.20 would be due to the locality (City of Richmond).

39. Estate Tax • Estate tax planning is an important part of financial planning as it involves decisions regarding wills, trusts and joint tenancy.

40. Estate Tax… • When planning an estate, current federal and state taxes should be considered, as well as any deductions and exemptions that apply to those taxes. • Only estates exceeding the exempt amount ($3,500,000.00 after January 1, 2009) are taxed by the federal government. • This tax applies to the gross worth of the decedent’s estate at the time of death (not time of purchase), with a large portion of the estate exempted by a tax credit. (Reminder: A tax credit is a reduction of the tax itself)

41. Estate Tax… • Estate planning answers the following questions: • How does a person want his or her estate distributed after death? • Who will be appointed to distribute the estate? • What are the decedent’s wishes regarding the care of those left behind (ex: Minor children, legal guardians)?

42. Estate Tax… • Inheritances (a title to property or estate that passes by law to the heir on the death of the owner) are generally not taxed by the federal government, but several states have inheritance taxes. • Virginia does not have an inheritance tax.

43. Activity and Lesson

44. Exemptions, Deductionsand Credits When a taxpayer files a federal return, he/she should take the time to become familiar with exemptions, tax deductions and tax credits which can reduce the possible amount of tax owed to the government.

45. Exemptions, Deductionsand Credits… Exemptions Personal tax exemptions reduce your taxable income. Each personal tax exemption you claim is the equivalent of a tax deduction.

46. YOU ARE YOUR FIRST EXEMPTION!!!!

47. Exemptions, Deductionsand Credits… Generally, you are allowed one tax exemption for yourself. If you are married you are allowed one tax exemption for your spouse. If you have dependents, you are allowed one tax exemption for each dependent on your tax return.

48. Exemptions, Deductionsand Credits… Deductions Deductions reduce the taxes a taxpayer must pay by reducing a person’s taxable income.

49. Exemptions, Deductionsand Credits… Some possible deductions are: • Student loans • State and local taxes paid • Age deduction • Charitable contributions • Interest paid on home mortgage • Child care expenses

50. Exemptions, Deductionsand Credits… Tax Credits A tax credit reduces the tax you owe by subtracting the amount of the credit from the tax due.