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Personal Finance Chapter 3 - baj01275_c03_042-074.qxd...

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Starting Point Go to www.wiley.com/college/bajtelsmit to assess your knowledge of managing your taxes. Determine where you need to concentrate your effort. What You’ll Learn in This Chapter The major features of the U.S. federal income tax system Tax basics How taxes are calculated How to file tax returns Tax planning strategies After Studying This Chapter, You’ll Be Able To File your taxes on time Calculate taxable income and determine your tax liability Select strategies to legally minimize the taxes you pay 3 MANAGING YOUR TAXES The Basics of the U.S. Tax System baj01275_c03_042-074.qxd 2/09/07 02:05am Page 42
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3.1 THE BASICS OF FEDERAL INCOME TAX 43 INTRODUCTION Taxes can take a big bite out of your budget, so your strategies for legally min- imizing your taxes are crucial to your financial plan. It’s important to consider the tax implications of your potential financial decisions and to be proactive in developing a plan to minimize tax payments. In this chapter, you’ll first exam- ine the main features of the federal income tax system and the requirements for filing, calculating, and paying taxes. Federal income taxes are the focus of this chapter because they take the biggest tax bite. Finally, this chapter discusses the most common tax planning strategies. 3.1 The Basics of Federal Income Tax There’s no question—the U.S. federal income tax system is complicated. The statutes and regulations that describe the tax laws fill literally thousands of pages, and it is estimated that the average taxpayer spends more than 10 hours per year filling out the required forms. It’s a good idea to make one of your personal financial goals to learn more about the tax system so that you can keep adequate records and reduce what you owe. Your income tax is one of your household’s largest cash outflows, and you work around four months out of the year just to pay your federal taxes. 3.1.1 The Progressive U.S. Tax System Although there have been many changes in the tax law throughout our coun- try’s history, the United States has always maintained a progressive tax, one that imposes higher tax rates on taxpayers with higher incomes, requiring them to pay proportionately more in taxes, through either higher tax rates or other rules. In its infancy, the United States had no income tax at all. It wasn’t until the 16th amendment to the U.S. Constitution was passed in 1913 that Congress imposed a tax on income, which was necessary to pay national security expenses associated with World War I. Since that time, tax rates have increased or decreased based on economic and political circumstances. Today, federal income taxes are used to finance many worthwhile government activities, including the national defense, education, social programs, drug safety, transportation, and road maintenance.
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