April 9mgmt127a

April 9mgmt127a - April 9 2008 MGMT 127A Tax...

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April 9, 2008 MGMT 127A Tax Liability -Prepayments General rule for prepayments- pay in amount during the year that covers your bill Paid in from- -Employers withholding on paychecks (for wages only) -Voluntarily sent in from anything that is not wages If all of it arrives, there is no penalty. If you don’t send in all of it, you will be assessed an interest charge. However, there will be no interest charge if you meet one of the three conditions (payment within $1000, payment of 90%, pay in the same you did in the previous year). Example Taxes are equal to $30,000 and you pay in $27,000 Example During your junior year of college, you had no income. You worked for the last four months of your senior year. You don’t have to pay any tax for that year because the previous year’s bill was zero. You will pay taxes on April 15 during your first full year of employment. You don’t get out of paying tax. You just avoid paying it for 6 months. Effectively, you save 6 months of interest.
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During your first full year, you have 12 months of income vs. 4 months of income the previous year. Does your tax bill triple because your income tripled? Does it more than triple? Does it less than triple? Since we have a progressive tax system, the tax bill you have after the full year of employment will more than triple. What if we had a flat tax? The bill still more than triples Year 1 Year 2 $16 $40 (8) (8) ______ ______ $8 $40 The tax more than triples because the write offs (standard deduction and personal exemption) remain fixed. The top line has less than tripled, but the bottom line has more than tripled. (Gross income tripled, but deductions remained the same). There are two reasons why taxes will be higher during a full year of employment 1. Progressive tax system 2. “Leveraging Effect”- Fixed write off that doesn’t move proportionally Since the bottom line was 5 times greater in year 2, under a flat tax, you would have paid 5 times more in tax. When your bottom line goes up 5 fold in a progressive tax system, your tax liability goes up by “8, 10 or 12” fold.
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