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Income - Head Matters


2. Taxes and Benefits

a. Describe the tax deductions, tax credits and personal exemptions we receive that encourage us in certain behaviors and cut out tax bill

In looking at the affects of taxes on our disposable income, it is important that we discuss how our federal tax bill is figured and the adjustments we can make to our gross income with deductions, exemptions, and credits.  These help lower our tax liability and thereby increase our disposable income.
  • Exemptions – When you are figuring your federal income tax liability, you don’t pay based on the total income you’ve earned.  First, you are allowed to subtract an amount for exemptions – to exempt a portion of your income to pay for a portion of your basic needs and other people you may support.  You are an exemption; if you have a spouse, that person is an exemption; if you have children, each of them is an exemption, and, in 2009, each exemption means $3,650 is subtracted from your total income.
  • Deductions –  You can deduct expenses like contributions to charities.  The government wants you to give to charities which often provide services that the government doesn’t.  The government also wants to encourage home ownership, so it allows deductions for mortgage interest and property taxes.  Even if you have no deductions, you are allowed to subtract a “standard” deduction, which in 2009 is $5,700 if you are single and $11,400 if married.
  • Adjusted gross income – That’s right, you are allowed to adjust your gross income; that is, the government wants to encourage certain behaviors by allowing you to subtract the expenses for those behaviors from your gross income.  For example, as stated earlier, if you put money into certain types of retirement savings accounts, you are allowed to subtract that from your income because the government wants you to prepare for your retirement.  If you participate in an employer sponsored retirement savings plan, like a 401K, those subtractions occur when the amount of tax to be deducted from your paycheck is calculated. If you contribute to a separate retirement savings plan outside of your employer, like an IRA,  you can deduct that amount from your gross income. If you are self-employed and must pay your own health insurance, the government wants to encourage you to buy it and therefore allows that cost as a deduction.  You are encouraged to further your education because certain tuition and fee costs and student loan interest costs are deductible.  Many scholarships, fellowships and need-based education grants are tax-free – if you are a candidate for a degree at an eligible education institution and the scholarships or grants were used to pay for those qualifying educational expenses. 
  • Credits – Sometimes, to encourage certain behaviors, they offer tax credits.  For example, because of the energy shortage, we are encouraged to buy hybrid cars which run on a combination of electricity and gasoline.  By doing so, we help preserve the nation’s gas supply; in return, we are allowed to take a tax credit.  A tax credit is an even better incentive than a deduction.  A deduction lowers the gross income on which you are taxed, so, if you are in a 15 percent tax bracket, you save 15 percent of the amount from your total tax bill.  If the hybrid car were a deduction, you would save $450.  But because it is a tax credit, you save the full $3,000.
  • Earned Income Tax Credit – Workers who don’t make much money can apply for “earned income tax credit”, that is, they may be eligible to get a tax refund even if they didn’t pay any tax.  In 2009, workers supporting two or more children could receive $5,028, supporting one child, $3,043, with no children, $457.  To be eligible, the adjusted gross income for a single filer must be less than $11,490; with one child, $30,338; with two or more children, $34,458 in 2004.
By understanding the tax system and using the provisions designed to encourage you to follow certain behaviors that are either good for you or for society, you can increase your disposable income by lowering your tax expenses.  


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