Taxes Exam Review Part 1

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Taxes Exam Review (Part 1) True/False Indicate whether the statement is true or false. 1. INCOME TAX PRINCIPLES 2. Individuals in the US are subject to federal income taxes. 3. Some states in the US do not have state income taxes. 4. In the US, higher incomes face a higher income tax bracket those with lower incomes. 5. In the US, all individuals are allowed to exempt certain income from taxes. 6. In the US, all individuals are allowed to deduct certain expenses. 7. There is a difference between gross income and taxable income. 8. Taxable income = gross income minus exemptions and deductions. 9. The US individual tax code is complicated as there are many rules for what qualifies as a deduction. 10. Individuals get to either itemize deductions (i.e. count up their deductions) or take the standard deduction (i.e. use a fixed deduction). 11. INCOME TAX BRACKETS 12. A tax is regressive if the tax rate falls as income declines. 13. There is a difference between an average tax rate and a marginal tax rate. 14. In the US, higher income individuals have higher marginal tax rates. 15. As a result of recent income tax law changes, the highest marginal tax rate has fallen. 16. If an individual is in the 25% marginal tax bracket for federal income taxes and receives a $2,000 year end bonus, then he will pay an additional $500 in federal income tax. 17. SOCIAL SECURITY AND MEDICARE: Basics 18. Social security is designed to provide people a financial safety net. 19. Social security consists of three main parts: disability income, survivor benefits, and retirement income.

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Taxes Part 1

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20. There is a maximum social security benefit for retirees (for 2009 it is $2,323 a month for those at full retirement age). 21. Medicare provides health insurance for the elderly. 22. In order to qualify for Social Security, a worker needs to earn enough credits. 23. For those born after 1960, the minimum retirement age for Social Security is 62 and the full retirement age is 67. 24. SOCIAL SECURITY AND MEDICARE: Taxes 25. All earned income is subject to social security tax. 26. For employees, 6.2% is deducted from their paychecks for social security and the employer contributes 6.2% as well. 27. For those who are self-employed, they must pay both the employee and employer contributions to Social Security . 28. For those who are self-employed, they must pay both the employee and employer contributions to Medicare. 29. For employees, 1.45% is deducted from their paychecks for medicare and the employer contributes 1.45% as well. Problems 30. INCOME TAXES 31. Suppose you have the following marginal income tax rates Income $0 to $10,000 $10,001 to $40,000 $40,001 and above

Marginal Tax Rate 0% 10% 25%

Suppose your annual salary is $60,000. (a) What is your marginal tax rate? (b) What is the total tax paid? (c) What is your average tax rate? (d) If you get a $5,000 bonus, do you use your marginal tax rate or your average tax rate to determine the additional income tax you need to pay as a result of your bonus?

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Taxes Part 1

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32. Suppose you have the following marginal income tax rates Income $0 to $10,000 $10,001 to $40,000 $40,001 and above

Marginal Tax Rate 0% 10% 25%

Compute the following table: Income

Taxes Paid

Average Tax Rate

$5,000 $15,000 $25,000 $35,000 $45,000

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Marginal Tax Rate

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Taxes Exam Review (Part 1) Answer Section TRUE/FALSE 1. ANS: T 2. ANS: T 3. ANS: T Florida and Nevada are examples of states with no income taxes. 4. ANS: T 5. ANS: T This is mostly true. For very high income earners, exemptions are often phased out. 6. ANS: T Individuals can either itemize or take a standard deduction. Although for very high income earners some deductions are not allowed. 7. ANS: T 8. ANS: T 9. ANS: T 10. ANS: T You have a choice of trying to keep track of where you money gets spent or use fixed number. If your itemized deductions sum up to be larger than the standard deduction, you can use that larger number to reduce your taxable income. 11. ANS: T 12. ANS: F In a regressive tax system, the tax rate is higher for lower income groups. So the tax rate rises as income declines. 13. ANS: T This difference was discussed in class. 14. ANS: T 15. ANS: T G.W. Bush has lowered the marginal tax rates and introduced a 10% tax bracket. The top federal income tax bracket is now 35%. There is an expectation that is is likely to change with the Obama administration. ANS: T ANS: T ANS: T ANS: T ANS: T See: http://www.ssa.gov/pressoffice/factsheets/colafacts2009.htm 21. ANS: T 22. ANS: T For 2009, a credit was given for every $1,090 earned, up to 4 credits per year can be earned. See: http://www.ssa.gov/pressoffice/factsheets/colafacts2009.htm 16. 17. 18. 19. 20.

Workers need to accumulate enough credits to qualify for social security (or to have a spouse who earned enough credits.) 1

ID: A 23. ANS: T If individuals can retire early at age 62, but there is a financial penalty for doing so. The benefit at age 62 is 70% of what it would be at age 67. Source: http://www.socialsecurity.gov/retirement/1960.html 24. ANS: T 25. ANS: F For 2009, social security taxes are paid on wages up to $106,800. 26. ANS: T For 2009, this happens for wages up to $106,800. 27. ANS: T 28. ANS: T 29. ANS: T Unlike social security, there is no income limit for medicare taxes. PROBLEM 30. ANS: . 31. ANS: (a) Since you make more than $40,000, your marginal tax rate is 25%. (Note tax brackets and marginal tax rates both mean the same thing.) (b) You pay 0% on your first 10,000 of income, 10%on your next 30,000 of income, and 25% on your next 20,000. This totals to $0 + $3,000 + $5,000 = $8,000. 8,000 = 13.33%. (c) Your average tax is 60,000 (d) You use your marginal tax rate of 25%. 32. ANS: Hint: Use the previous problem as a guide to solve this problem.

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