Earning Money and Paying Taxes

Professor Annette Nellenhttp://www.cob.sjsu.edu/nellen_a/

Agenda

Why we have taxes What types of taxes we pay and how we pay

them Who pays taxes Where we pay taxes Some financial planning reminders regarding

taxes Seeking advice

Why we have taxes

“Taxes are what we pay for a civilized society.”

Oliver Wendell Holmes, former Justice of the US Supreme Court (1927)

IRS headquarters at 1111 Constitution Avenue in Washington DC

Purpose of taxes Primary purpose – raise funds for government operations Secondary purposes:

Change behavior – penalties (negative) and credits (positive) Examples:

Tax on cigarettes Penalty for paying your taxes late Tax credit for buying a hybrid car

Provide assistance and subsidies Examples:

Earned Income Tax Credit (EITC) Stimulus payments Home mortgage interest deduction Various deductions and tax credits for higher education

What types of taxes we pay and

how we pay them

ABC Department Store

10/13/09

Jeans $45.99Tax $ 4.25Total $50.24

Please come again!

Types of taxesType of tax Federal California San Jose

Income tax X X

Sales tax X X

Use tax X X

Property tax X

Excise taxes X X

Employment X X

Estate/gift X X

Business license X

Transient occupancy tax

X

Your paycheck

http://www.taxes.ca.gov/Income_Tax/paycheckind.shtml

Being self-employed

Many tax obligations: Quarterly estimated income tax payments to federal and

state governments (and some cities, such as NYC, have income taxes) Also owe self-employment tax (similar to what employees

pay for Social Security and Medicare taxes) Penalties if pay late or don’t pay enough

Business license tax If required to charge sales tax to customers, must register

with state to collect sales tax and file quarterly forms May be other types of taxes depending on your business

and where it operates

Who pays taxes

Federal taxes

IRS, Fiscal year 2007, http://www.irs.gov/pub/irs-pdf/i1040.pdf

California taxes

California Revenues

http://www.lao.ca.gov/2006/cal_facts/calfacts_budget_2006.pdf

Paying directly and indirectly

Per US Census Bureau Total state and local taxes paid as percent of

income for a family of 3 living in Los Angeles for 2006 $25,000 10.8% $50,000 9.9% $75,000 10.0% $100,000 9.7% $150,000 10.4%

[http://www.census.gov/compendia/statab/tables/09s0429.pdf]

Where we pay taxes - 1

Income taxes – paid through withholding from paychecks or estimated tax payments, but also file Form 1040 (federal) or Form 540 (California) annually.

Sales tax – when we buy something; seller collects

Use tax – when we buy a taxable item but were not charged sales tax. Pay the use tax on your California income tax form (540)

Where we pay taxes - 2

Property taxes – County assessor sends us a bill OR you may have arranged for your mortgage lender to handle payment

Business taxes Various forms Federal + State(s) + cities and counties and

special districts

Financial Planning Recordkeeping – so can file accurate tax return

Question – what to keep track of? Don’t forget about the effect of taxes on financial plans:

Retirement savings (usually not taxed currently, but taxed when withdrawn at retirement)

Comparing different investment strategies – look at after-tax rates of return.

Tax aspects of finances Look into available tax breaks (tax rules that will reduce your

taxes) Be sure taxes are paid on time. Don’t forget that you may be directly liable for more than income

taxes. EX – business owner, including a self-employed consultant, probably

owes business license tax to city(ies) in which they work

Advice from the IRS

“After you enter the workforce, it is essential to keep accurate financial records.” http://www.irs.gov/app/understandingTaxes/stude

nt/whys_thm06_les02.jsp IRS website has lots of helpful information to

explain taxes and tax effect of investments and retirement plans + many publications in easy-to-read style. www.irs.gov

Seeking advice

Not everyone who prepares returns and offers financial advice for a living knows what they are talking about. There are many unscrupulous tax preparers out there. Ask about their experience and certification. If they tell you something that sounds odd – do research on

your own or get a new preparer or adviser.

Be savvy enough (such as by taking this class) so you can ask good questions

Tax return preparers

CPAs and attorneys - licensed and follow a code of conduct; have varying degrees of tax knowledge depending on their area of practice

Enrolled agents (EA) – certified by the IRS; must pass a tax exam and take continuing education

California requires return preparers to pass a 60-hour course and post a bond. Thereafter, must get 20 hours of annual education.

IRS currently working on a plan that may require all paid tax return preparers to be registered or certified in some way.