Does federal income tax rate include social security and medicare

When it comes to income taxes, there are different types of people.

There are individuals who find pleasure in tackling the 1040 all on their own. At the other end of the spectrum, there are people who make a mad dash for the nearest H&R Block about 9 p.m. on April 15.

But no matter where you fall on that scale, it’s important to master the basics. Most of life’s milestones carry some sort of tax implication, whether it’s having a child, purchasing a home, changing jobs or, yes, even dying. And as you travel through life and your situation evolves, your approach to income taxes needs to be adjusted accordingly.

To complicate matters, the rule book is constantly changing. So taxpayers must sort through a befuddling mix of new rules, deductions and credits each year. For some people, all of the noise is justification enough to pay an accountant.

Even if you do, there is still a variety of issues you should be aware of that will help you maximize your tax savings. This guide will explain how income taxes work and how to trim your bill, and offer a few approaches to tax preparation.

Income Taxes

If you work in the United States, you will probably incur some sort of federal income tax liability each year. Most people will also owe state income taxes, though a handful of states like Florida and Texas don’t impose income taxes at all. (Pro athletes don’t settle there just for the sunny skies.) A few cities and townships add another layer to the mix of taxes you’ll pay; this list details what the various state and local governments charge.

The amount you owe — for federal, state and local taxes — is determined by how much you earn each year. The United States uses a progressive tax system, which means the more money you earn, the higher your tax rate. The chart above lays out the different tax brackets and rates, which depends on your filing status (single, married couples filing jointly, married filing separately, etc.).

Your employer will typically withhold income taxes from your paycheck. The precise amount withheld for federal income taxes depends on how you fill out your W-4 form, which is completed when you start a new job. You’re asked to provide information about your marital status and whether you have children or work more than one job. This information determines how many “personal allowances” you are eligible for — the more allowances you claim, the less that will be withheld from your paycheck. You can claim all of the allowance you’re eligible for, some of them, or none at all. In fact, if you’re married, you can still have taxes withheld at the higher, single rate.

Just remember that you don’t want to have too much withheld, thereby providing the government with an interest-free loan. The I.R.S. has a calculator that helps you aim for a number of allowances that will come close to matching the amount of tax you’ll owe.

Besides income taxes, there are other federal taxes withheld from your paycheck: taxes that finance Social Security and Medicare, also known as payroll taxes or FICA (short for Federal Insurance Contributions Act). You split these with your employer. You pay 6.2 percent of your gross income to cover the Social Security piece, up to a limit of $102,000; in 2009, that figure rises to $106,800. The Medicare tax is 1.45 percent of income, with no limit. Employers are responsible for contributing the same amount you do. (Payroll taxes are not withheld from your paycheck if you work for an international organization or if you’re a member of the clergy. You are responsible for paying them on your own.)

If you’re self-employed or a small-business owner, taxes become more even complicated because you’re required to handle everything on your own. That means figuring out how much you’ll need to set aside to cover income and self-employment taxes for Social Security and Medicare (You pay both employer and employee contributions, or 12.4 percent for Social Security and 2.9 percent for Medicare.) You’ll also need to make estimated tax payments each quarter, or face penalties. So be sure to read the I.R.S. guidelines or consult with a tax professional.

Cutting Your Tax Bill

There are several ways to lower your annual tax bill. The government allows you to deduct certain items from your gross income, or the amount you earn before taxes, thereby shrinking the pool of money you’re taxed on. This can be accomplished in several ways.

Exclusions: First, there are the items not listed on your tax returns. These are known as exclusions, and they either work to reduce your gross income — or, they don’t add to it. For instance, pretax contributions to your employer-sponsored retirement account or a flexible spending account will reduce your gross income, dollar for dollar. If you collect interest from a municipal bond investment, it won’t add to your gross income.

Above-the-Line Deductions: The next way to whittle down your gross income is through certain deductions available to all taxpayers, known as adjustments to gross income, or A.G.I. Once you subtract these — they include items like moving expenses, student loan interest and certain retirement contributions — you arrive at your A.G.I.

These items are more commonly known as “above the line” deductions because they appear above the line for adjusted gross income on your tax return. They are deemed more beneficial than “below the line” deductions, which are often subject to income limits or other restrictions. Meanwhile, your eligibility for other deductions will be based on your A.G.I. The smaller it is, the better.

Below-the-Line Deductions: Most taxpayers are also eligible for another tax reducer, known as the standard deduction; the amount of this deduction varies depending on your filing status (single, married filing jointly, etc.). But if your eligible individual deductions exceed the amount of the standard deduction — or you’re ineligible for the standard deduction — it makes sense to itemize.

Itemizing is more involved than simply taking the standard deduction; you’ll need to list each item on a form called Schedule A, which is part of the 1040. You can read more about determining which way you’ll come out ahead on the I.R.S. Web site. Some of the most common itemized deductions include mortgage interest, charitable donations, job-related expenses and certain losses arising from casualty, theft and the bankruptcy of your financial institution.

Credits: In addition to deductions, some taxpayers are also eligible for tax credits. These are dollar-for-dollar reductions of taxes owed. So, for instance, if you end up owing $2,000 in taxes, but are eligible for a $500 tax credit, your tax bill will drop to $1,500. This differs from a $500 tax deduction, which would simply reduce the amount of your income subject to tax by $500. Some of the most commonly used credits include the Earned Income Tax Credit, the Child and Dependent Care Credit and Education Credits.

If you itemize, you need to use the longer 1040 tax form instead of the abbreviated 1040EZ and 1040A forms. The 1040EZ is the easiest form for non-itemizers, but you must have taxable income below $100,000, file a single or joint return with no dependents, and be under age 65.

The 1040A is another shorter form for people who make less than $100,000 and who do not itemize. But married couples who file separately can also use it, and there are fewer restrictions on the types of income and credits you can claim.

Alternative Minimum Tax

Some taxpayers might be subject to the alternative minimum tax, which is a parallel tax system set up in 1969 to ensure that the wealthiest taxpayers paid their fair share of taxes. But since the A.M.T. was never indexed for inflation, it now entraps more upper-middle-income taxpayers. For the 2008 tax year, about 4.1 million taxpayers will be subject to the tax, up from 20,000 in 1970, according to the Urban-Brookings Tax Policy Center.

It tends to affect married people with children (and therefore multiple dependent exemptions), large property tax deductions and high state and local tax deductions. If you expect to be caught by the A.M.T., you should calculate your taxes twice, once under the regular system and again under the A.M.T. rules, which, in part, add back the deductions that are not allowed under its own set of rules and rates.

The alternative minimum tax also imposes a flat rate — of 26 percent and 28 percent — on a broader base of income. Taxpayers pay whichever amount is larger. In recent years, Congress has increased the amount of income exempt from the A.M.T. annually. For joint filers, that amount increases to $69,950 in 2008, from $66,250 in 2007, and, for singles, to $46,200 from $44,350.

Filing Taxes

There are a few ways to prepare your taxes.

Some people prefer to hand over all records, receipts and other paperwork to an accountant. Using a professional is often wise if you have a complicated situation that might include many investments, estate issues and other complexities.

Beyond recommendations from friends and family members, you can find a list of advisers through the National Association of Tax Professionals. Keep in mind that only certified public accountants, enrolled agents and tax lawyers can represent you before the I.R.S.

If you have a pretty straightforward situation, it’s much less expensive to prepare your own returns. Here are some options:

I.R.S. Free File: All taxpayers can file their federal returns online through the I.R.S. Web site. But if your income is $56,000 or less, you can use the Free File program, which provides access to free tax software. The companies that take part in this program have different eligibility requirements: start by reading the instructions, then hit its “Guide Me to a Program” tool, to see which companies’ software you qualify for. You’ll probably qualify to use several, but the quality differs widely. Remember that while this service is free for federal tax returns, the sites charge different amounts to process your state returns.

If you make more than $56,000, you can still fill out and file your federal forms electronically — free — through the “Free File Fillable Forms” program. But you do not get access to any tax software. That's why this option is best suited for people who know what forms they need to use and don’t need much hand-holding when completing their tax returns. Visit your state tax department's Web site to see what options it offers for electronic filing.

Tax Software: Several companies sell software that guides taxpayers through the filing process. You can buy these online (and download the software) or off the shelf. Prices range from roughly $25 to under $100. Some of the most widely known programs include TurboTax, H&R Block’s TaxCut and TaxAct.

Record Keeping

The rule of thumb is to keep all records supporting your tax return for seven years. The I.R.S. generally has three years to perform an audit. But if the tax man suspects you haven’t reported a sizable chunk of income (exceeding 25 percent of the gross income reported on your return), the I.R.S. can try to collect the remainder for up to six years. Details on what to keep and for how long are available in the I.R.S. guidelines.

Keep in mind that your records might need to be kept for other reasons, such as for insurance purposes or getting a loan.