Personal Finance

Topic 3. Taxes and Tax Planning

Seungho Shin, PhD, MBA

Spring 2024
Road Map

1 Introduction

2 Kinds of Taxes

3 References

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Introduction - Raising

A government’s budget is a plan for both raising and spending funds for governmental activities.
The two largest sources of government revenue are individual income taxes and social security
and medicare taxes. These two sources accounted for 85.5% of all U.S. federal tax revenue in
2019. Total tax revenue in 2019 was $3.46 trillion. Other taxes include corporate income taxes,
estate and gift taxes, and excise taxes.

(Source: Congressional Budget Office, Historical Budget Data)

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Introduction - Spending

Government outlays are the part of the government budget that includes both spending and
transfer payments.
1 Spending includes spending on military hardware, schools, roads, bridges, and wages for
government workers.
2 Transfer payments are payments made to groups or individuals when no good or service is
received in return. Transfer payments include income assistance and social security
payments to retired or disabled people. These are not part of government spending.

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U.S. Government Outlay Categories

1 Mandatory outlays
2 Discretionary outlays
3 Interest payments

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U.S. Government Outlay Categories - Mandatory Outlays

1 By far the largest portion of the federal budget is dedicated to mandatory outlays, which
go to ongoing government programs such as social security and medicare. These are
mandatory because existing laws mandate government funding for them. Mandate outlays
are not generally altered during the budget process; they require changes to existing laws.
Sometimes mandatory outlays are called entitlement programs because citizens who meet
certain requirements are entitled to the benefits under current laws.
2 Discretionary outlays are subject to adjustment during the annual budget process. These
include monies for infrastructures, payments to government officers, and defense spending.
3 Interest payments are payments made to current owners of U.S. Treasury bonds. For all
practical purposes, these interest payments are also mandatory because they are not easy
to alter, given a certain level of debt.

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Historical Federal Outlay Shares, 1970–2017

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Income Tax

The U.S. tax code is based on the idea that everyone should help finance the government
according to one’s ability to pay. The tax rates are progressive - that is, the higher one’s
income, the larger the percentage paid in taxes.
2019 U.S. Federal Tax Rates

(Source: Internal Revenue Service)

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Tax is levied on income from many different sources.
1 Wages (selling labor)
2 Interest, dividends, and gains from investment (selling capital)
3 Self-employment (operating a business or selling a product or service)
4 Property rental
5 Royalties (rental of intellectual property)
6 ”Other” income such as alimony, gambling winnings, or prizes

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Kinds of Taxes

a. A sales tax or consumption tax taxes the consumption financed by income. In the United
States, sales taxes are imposed by state or local governments, but there is no federal sales
tax.
b. The value-added tax (VAT) or goods and services tax (GST) is widely used outside the
United States. It is a consumption tax, but only paid by the consumer as an end user.

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c. Excise taxes are taxes on specific consumption items such as alcohol, cigarettes, motor
vehicles, fuel, or highway use. These taxes are justified by the discretionary nature of the
purchases and may be criticized as exercises in social engineering.
”Sin” Taxes Could Help Us Be Healthier (Click to Watch)

d. Property taxes are used by more local and state governments, and are most commonly
imposed on real properties such as land, buildings, vehicles, and boats.
e. Estate taxes or death taxes are taxes on the transfer of wealth from the deceased to the
living. These taxes are controversial because they can be seen as a tax on the very idea of
ownership and on incomes that have already been taxed and saved or stored as wealth and
properties.

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Individual Taxes

In the United States, tax filing season runs between January 1 and April 15 each year for filing
and resolving the previous year taxes.
1 The marginal tax rate is defined as the tax rate on the last dollar of income . In other
words, the tax rate is applicable to the last unit of both individual and corporate income
taxes.
2 The average tax rate is defined as the total tax paid divided by taxable income. It simply
shows the overall share of income paid in taxes.
3 The flat tax rate is defined as the single rate on the taxable income. That is, everyone
pays the same tax rate regardless of their income.

Additional Resources:
Federal Income Tax Brackets for Tax Years 2023 and 2024 (Click to Read)
IRS Online Learning and Educational Products (Click to Read)

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Individuals pay taxes on wages and salaries, on investment income (dividends, interest, and
profits from the sale of securities), and on the profits of proprietorships and partnerships. The
tax rates are progressive - that is, the higher one’s income, the larger the percentage paid in
taxes.

(Example: 2019-2020 Tax Brackets and Federal Income Tax Rates for Single filers)

2023-2024 Tax Brackets Federal Income Tax Rates (Click to Read)

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Payroll Taxes and Federal Income Tax Withholding

There are reasons why your paychecks are smaller than expected.
1 Employers withhold payroll taxes and income tax from employees’ pay.
2 Employers send the amounts withheld to the federal government, and complete Form W-4.
3 Employers use Form W-4 to determine how much income tax to withhold from employee
pay.

Forms, Instructions & Publications (Click to Read)

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Payroll Taxes

Social insurance programs benefit from payroll taxes. In general, Federal, state, Social Security,
and Medicare taxes are all part of payroll taxes. In this chapter, we mainly focus on the
collection of Social Security and Medicare taxes.

What is FICA? (Click to Read)

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Case 1. Payroll Taxes - Basic

Suppose Kelly earns $1,000. With an assumption that there are only two payroll taxes - Social
Security and Medicare taxes - what would be her total payroll tax amount?
1 Social Security tax amount
$1,000 X 6.20% = $62.00

2 Medicare tax amount

$1,000 X 1.45% = $14.50

3 Total payroll taxes

$62.00 + $14.50 = $76.50
The employer deducts $76.50 from employee’s pay and it will be sent to the federal government.

Starting in January 202X, Kelly will start earning $1,500 due to her recent promotion to her new
position. If this is the case, what will be the total amount she pays in payroll taxes? Assume
that payroll taxes are only imposed on Social Security and Medicare.

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Case 2. Payroll Taxes - Intermediate
Suppose Thomas makes $5,000 a month by selling illegal(?) drugs in Dubuque, IA. In addition
to payroll taxes and income tax withholding, his employer, Al Capone, withholds $550 for his
retirement account. Based on the information, what would be Thomas’s net pay? Assume that
his income tax is $770.
1 Social Security tax amount
$5,000 X 6.20% = $310.00

2 Medicare tax amount

$5,000 X 1.45% = $72.50

3 Retirement account
$550.00

4 Income tax
$770.00

5 Net pay
$5,000 - $310 - $72.50 - $550 - $770 = $3,297.50
Thomas earns $5,000 gross pay and receives a net paycheck for $3,297.50. His employer, Al
Capone, will send $1,152.50 to the federal government and $550 to the retirement fund.

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Short Summary

1 Employers withhold payroll taxes and income tax from employees’ pay.
2 Employers send the amounts withheld to the federal government.
3 Employees complete Form W-4.
4 Employers use Form W-4 to determine how much income tax to withhold from an
employee’s pay.

Tax Withholding (Click to Read)

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Corporate Taxes

Corporate tax is simple because the federal corporate tax rate is a flat rate that applies to all
corporations.

Corporate Tax Rates by Country 2024 (Click to Read)

Room for Debate: Are higher taxes or lower taxes better for society?
In modern society, economists, researchers, and practitioners have debated whether wealthy
people or corporations should pay more in income taxes. Sadly, there is no clear answer!

How The Wealthy Hide Billions Using Tax Havens? (Click to Watch)

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Case 3. Korean Fried Chicken (KFC)

If Korean Fried Chicken (KFC) had $1,342,300 of taxable income and the federal-plus-state
corporate tax rate of 25%, its tax bill would be $335,575.

$1,342,300 X 25% = $335,575

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References

Internal Revenue Service. (2024). Form 1040: U.S. Individual Income Tax Return. Retrieved
from https://www.irs.gov/pub/irs-pdf/f1040.pdf.

Siegel, R. (2020). Personal Finance. (3.1 ver.). FlatWorld.

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