ANSWERS TO CONCEPT CHECKS, FINANCIAL PLANNING PROBLEMS

AND QUESTIONS, AND CASES

CONCEPT QUESTIONS
Concept Check 3-1 (p. 63)
1. What are the four major categories of taxes?
Taxes on purchases, taxes on property, taxes on wealth, and taxes on earnings.
2. For each of the following situations, list the type of tax that is being described.
Financial planning situation
(a) A tax on the value of a persons house.
(b) The additional charge for gasoline and air travel.
(c) Payroll deductions for federal government retirement
benefits.
(d) Amount owed property received from a deceased person.
(e) Payroll deductions for a direct tax on earnings.

Type of tax
property tax
excise tax
Social Security tax
inheritance tax
income tax

Concept Check 3-2 (p. 69)

1. How does tax-exempt income differ from tax-deferred income?
Tax-exempt income is not subject to taxation. Tax-deferred income is income that will be
taxed at a later date.
2. When would you use the standard deduction instead of itemized deductions?
The standard deduction would be used when a person does not have at least that amount in
itemized deductions. A taxpayer with no or few itemized deductions still receives the standard
deductionan amount on which no taxes are paid.
3. What is the difference between your marginal tax rate and your average tax rate?
The marginal tax rate refers to the rate used to calculate the last (and next) dollar of taxable
income. The average tax rate is based on the total tax due divided by taxable income.
4. For each of the following, indicate if the item is a TAX DEDUCTION or a TAX CREDIT.
Check the appropriate box to indicate if this
is
(a) state personal income taxes paid
(b) charitable donations
(c) child-care costs
(d) moving expenses

a tax deduction, or

a tax credit.

X
X
X
X

Concept Check 3-3 (p. 77)

1. In what ways does your filing status affect preparation of your federal income tax return?
A persons filing status, which is determined by marital status and dependents, will affect the
amount of the standard deduction and the tax schedules that are used.
2. What are the main sources available to help people prepare their taxes?
The main sources of tax assistance are IRS publications and services, other tax publications,
the Internet, computer software, and tax preparers.
3. What actions can reduce the chances of an IRS audit?
By correctly reporting all income and properly taking advantage of deductions and tax
credits, a person can reduce the chances of an audit. When unusual income or expense occurs,
you may want to include an explanation of the item with the tax return.
4. Which 1040 form should each of the following individuals use? (check one for each
situation.)
Tax situation
a. A high school student with an after-school job and interest earnings
of $480 from savings accounts.
b. A college student who, due to ownership of property, is able to
itemize deductions rather than take the standard deduction
c. A young, entry-level worker with no dependents and income only
from salary.

1040EZ

1040A

X
X
X

Concept Check 3-4 (p. 81)

1. How does tax avoidance differ from tax evasion?
Tax avoidance refers to the use of legitimate methods to reduce ones taxes. Tax evasion is
the use of illegal actions to reduce taxes.
2. What common tax-saving methods are available to most individuals and households?
Common tax-savings efforts include owning a home with a mortgage (property taxes and
mortgage interest are deductible), making purchases that may be deducted as job-related
expenses, selecting tax-deferred and tax-exempt investments, owning your own business, and
participating in a tax-deferred retirement plan.
3. For the following tax situations, indicate if this item refers to tax-exempt income or taxdeferred income.
(a) Interest earned on municipal bonds
(b) Earnings on an individual retirement account
(c) Education IRA earnings used for college expenses
(d) Income of U.S. citizens working in another country

Tax-exempt
X

Tax-deferred
X

X
X

1040

PROBLEMS AND QUESTIONS (p. 83)

1. Thomas Franklin arrived at the following tax information:
Gross salary, $41,780
Dividend income, $80
Itemized deductions, $3,890

Interest earnings, $225

One personal exemption, $2,650
Adjustments to income, $1,150

What amount would Thomas report as taxable income?

Thomas would have a taxable income of $34,595 resulting from $41,780 + $80 + $225 $1,150 - $3,890 - $2,450.
2. If Lola Harper had the following itemized deductions, should she use Schedule A or the
standard deduction? The standard deduction for her tax situation is $6,050.
Donations to church and other charities, $1,980
Medical and dental expenses exceeding 7.5 percent of adjusted gross income, $430
State income tax, $690
Job-related expenses exceeding 2 percent of adjusted gross income, $1,610
The standard deduction of $6,050 is better than itemizing deductions which totaled $4,710.
3. What would be the average tax rate for a person who paid taxes of $4,864.14 on a taxable
income of $39,870?
The average tax rate would be 12.2 percent.
4. Based on the following data, would Ann and Carl Wilton receive a refund or owe additional
taxes?
Adjusted gross income, $43,190
Itemized deductions, $11,420
Child care tax credit, $80
Federal income tax withheld, $6,784
Amount for personal exemptions, $7,950
Tax rate on taxable income, 15 percent
Taxable income would be $23,820 ($43,190 - $11,420 - $7,950) times the average tax rate of
15 percent equals $3,573 less a tax credit of $80 gives a tax liability of $3,493. When
compared to federal tax withheld ($6,784), the result is a refund of $3,291.
5. Using the tax table in Exhibit 35 (p. 74) determine the amount of taxes for the following
situations:
a. A head of household with taxable income of $26,210. ($3,434).
b. A single person with taxable income of $26,888. ($3,731).
c. A married person filing a separate return with taxable income of $26,272. ($3,992).
6. Use IRS publications and other reference materials to answer a specific tax question. Contact
an IRS office to obtain an answer for the same question. What differences, if any, exist
between the information sources?
This activity can help students better understand the federal income tax return preparation
process. In addition, they should realize that certain tax matters regarding income and
deductions may be open to interpretation

7. Would you prefer a fully taxable investment earning 10.7 percent or a tax-exempt investment
earning 8.1 percent? Why?
Assuming a 28 percent tax rate, 10.7 percent times 0.72 equals 7.704 percent; an 8.1 percent
tax-exempt return would be preferred.
8. On December 30, you decide to make a $1,000 charitable donation.
a. If you are in the 27 percent tax bracket, how much will you save in taxes for the current
year?
$270 tax savings
b. If you deposit that tax savings in a savings account for the next five years at 8 percent,
what will be the future value of that account?
$270

1.469 = $396.63

INTERNET CONNECTION (p. 84)

After obtaining this data, students should be able to discuss the value of various web sites for tax
information.
CASE IN POINT (p. 85)
A Single Fathers Tax Situation
1. What are Erics major financial concerns in his current situation?
Erics major financial concerns include providing for the current and future financial needs of
his daughters, weak tax-planning activities, and limited use of investments with tax benefits.
2. In what ways might Eric improve his tax planning efforts?
Eric could take advantage of child care tax benefits, change his withholding amount to avoid
owing a large amount in April, and investigate tax-exempt or tax-deferred investments.
3. Calculate the following
a. What is Erics taxable income? (Refer to Exhibit 31, page 64.)
Taxable income is $26,180
($42,590 + $125 + $65 - $2,000 - $8,250 - $6,350)

b.

What is his total tax liability? (Use Exhibit 35, page 74.) What is his average tax rate?
Tax liability is $3,026 ($3,426 from tax table less $400 tax credit). His average tax rate is
11.56 percent ($3,026 divided by $26,180).

c. Based on his withholding, will Eric receive a refund or owe additional tax? What is the
amount?
Eric receives a refund of $152. ($3,178 withheld less $3,026 liability.)