Today you will learn the basic process used to prepare an individual income-tax return and the responsibilities taxpayers have when complying with tax laws.
By the end of the lesson, you should be able to:
- Identify common tax documents.
- Put the basic tax-filing process in order.
- Explain gross income and taxable income.
- Explain tax liability, withholding, refunds, and balances due.
- Distinguish lawful tax avoidance from tax evasion.
This lesson addresses Michigan Finance competency A3. Accounting_A_A3_A4_Tax_Complian…
Bell Ringer
Why can a person receive a tax refund even though income tax was withheld from their paycheck all year?
Be prepared to explain your answer.
Common Tax Documents
Before preparing a tax return, taxpayers should gather the documents and records needed to report income and determine taxes already paid.
W-2
A W-2 is generally provided by an employer.
It may report:
- Wages
- Federal income tax withheld
- State income tax withheld
- Social Security information
- Medicare information
1099
A 1099 may report income received from sources other than a traditional employer.
Examples may include:
- Freelance income
- Independent-contractor income
- Interest income
- Other reportable income
Other Supporting Records
Taxpayers may also need:
- Receipts
- Records supporting deductions
- Records supporting credits
- Other financial documents needed to prepare the return
The Individual Income Tax Filing Process
Step 1 — Gather Records
Collect W-2s, 1099s, and other supporting documents.
Step 2 — Determine Filing Requirements and Filing Status
Determine whether a return must be filed and which filing status applies.
Step 3 — Report Income
Identify and report applicable income.
Step 4 — Determine Taxable Income
Apply applicable adjustments and deductions.
Step 5 — Determine Tax and Credits
Calculate the tax and apply eligible credits.
Step 6 — Compare Tax With Payments and Withholding
Compare the tax liability with taxes already paid.
Step 7 — Determine Refund or Amount Due
If payments exceed the tax liability, the taxpayer may receive a refund.
If the tax liability is greater than the amount paid, the taxpayer may owe additional tax.
Step 8 — File and Pay
File the return accurately by the required deadline and pay any amount due.
Step 9 — Retain Records
Keep appropriate records and protect personal and financial information. Accounting_A_A3_A4_Tax_Complian…
Important Vocabulary
Gross Income
Income before applicable adjustments and deductions.
Taxable Income
The amount of income that is subject to income tax after applicable adjustments and deductions.
Tax Liability
The amount of tax calculated under applicable tax law.
Withholding
Money taken from an employee's paycheck and sent toward the employee's tax obligation.
Tax Credit
An amount that may reduce the tax owed.
Refund
An amount returned to the taxpayer when payments and withholding exceed the final tax liability.
Balance Due
An amount the taxpayer still owes when the final tax liability is greater than the amount already paid.
Example
A taxpayer had:
Federal income tax withheld: $3,200
Final tax after credits: $2,850
Calculate:
$3,200 − $2,850 = $350
The taxpayer would expect a:
$350 refund
Taxpayer Compliance Responsibilities
Taxpayers are responsible for:
- Reporting income accurately
- Keeping appropriate records
- Meeting filing deadlines
- Paying required taxes
- Protecting personal information
- Protecting financial information
Accurate records help support the amounts reported on a tax return. Missing deadlines may result in penalties or interest. Protecting tax information is important because it contains sensitive financial and identity information. Accounting_A_A3_A4_Tax_Complian…
Tax Avoidance vs. Tax Evasion
Tax Avoidance
Tax avoidance uses lawful methods to reduce taxes.
Examples may include properly using deductions or credits allowed by law.
Tax Evasion
Tax evasion involves intentionally hiding or misstating information to avoid paying tax that is legally owed.
Tax avoidance is legal.
Tax evasion is not. Accounting_A_A3_A4_Tax_Complian…
Activity — Tax Filing Process
Put the following steps in the correct order:
- Determine refund or balance due
- Gather tax documents
- Determine taxable income
- File the return
- Determine filing status
Then identify a document or calculation associated with each step.
Exit Ticket
Answer each question in one or two sentences.
1. Identify one important step in the tax-filing process.
2. Identify one record a taxpayer should keep.
3. Explain one possible consequence of failing to comply with tax requirements.