Like I promised, this blog will be all about taxes. We learned a lot about taxes in class last week and I feel like since it is tax season, it would be a good post to put up. It seems like you don’t have to hardly know anything about taxes to be able to file them yourself online. All the different tax programs make it really easy. However, I think there are some things that everyone should know about taxes. It’s your money, don’t you want to know how to get the most back and how much you are actually paying for taxes? So, here are some key terms that I thought I should explain.
Income: obviously, this is the money you bring in. Everyone knows this. But, there are a lot of different terms that include the word income that you should know. Here they are:
- Total income: compensation from all sources. This is your income from your job, selling things, side work, interest, any money you bring in at all. This includes cash, property, or services.
- Earned income: This is the money that you make from work that you have done. This doesn’t include interest or anything that you didn’t have to work for.
- Gross income: all income in the form of money, goods, and services, and/or property. This term is similar to total income.
- Adjusted gross income: This is your gross income minus any exclusions or adjustments (we’ll get to those in a minute).
- Pretax income: This is the amount of income that is withheld from a worker’s salary before taxes are calculated. This would be money that you put into a tax deferred savings account. This money doesn’t go towards your taxes.
- Unearned income: This type of income includes investment returns in the form of rents, dividends, capital gains, interest, or royalties
- Taxable income: This is the amount which taxes are taken out of. This is your gross income minus your adjustments, deductions, and exemptions.
Okay, now I will explain some tax-specific terms.
- Exclusions: income not subject to federal taxation. This includes gifts, inherited money, cash rebates, tax refunds, mileage expenses not paid for by an employer, contributions to a flexible spending account, child support payments, and many other things. The list goes on for while. It is important to check this list to see if you can lower your taxable income.
- Adjustments: (or adjustments to income) These are allowable subtractions from your gross income. Some things that are included are moving expenses to a new job or a first job if it is more than 50 miles from your last location, higher-education expenses, student loan interest, contributions to an IRA or 401K or health savings account, alimony, expenses of up to $250 for teachers and other school professionals for school supplies, and some expenses of people who are self employed. This is another list that is helpful to look up when filing your taxes. The smaller you can get your final taxable income number to be, the better.
- Deductions: there are two different types of deduction that people talk about when discussing taxes. They are standard deduction and itemized deductions. Standard deductions are a set amount that all taxpayers can subtract from their adjusted gross income if you choose not to use itemized deductions. Itemized deductions are tax deductible expenses. Using itemized deductions is a lot more work, but it is worth it if you are able to lower your tax liability. In order to itemize your deductions, you need to keep detailed records of all the times you spend money on something that is deductible. Those items include
- Medical and Dental expenses that aren’t paid by insurance. The amount you deduct in this category can’t be more than 7.5% of your adjusted gross income.
- Taxes you paid
- Interest you paid
- Gifts to charity
- Casualty and Theft losses not paid by insurance in excess of 10% of adjusted gross income
- Job expenses
The standard deduction for a single person is $5800. For a married couple filing jointly, it is $11,600. People over 65 and/or blind can deduct an additional $1450 for singles and $1150 for married couples. If your itemized deductions are less than your standardized ones, you obviously want to use standardized deductions.
- Exemption: an exemption is a legally permitted amount deducted from adjusted gross income based on the number of people that the taxpayer’s income supports. A married man with two children would have four exemptions (the man is included).
- tax credit: dollar for dollar decrease in tax liability. There are two different types of credits: nonrefundable tax credits and refundable tax credits. Nonrefundable credits are those that can reduce your tax liability, however, if it reduces it to zero, that is as far as it goes. With a refundable credit, it can be reduce to below zero, and then the tax payer would receive a refund.
Once you figure out your taxable income, you must loot at a tax-rate schedule to figure out the amount (if any) of taxes you owe. The United States uses a marginal tax rate, which means that as your income goes up, the percentage your a taxed goes up as well. However, lets say you are in the 25% range. That does not mean that your whole income is taxed at 25%. Lets look at a chart to see how it all works: (for a single person)
If taxable income is over — But not over — the tax is —
$ 0 $8,500 10% of the amount
$8,500 $34,500 $850 (10% of 8,500) plus 15% of the amount over $8500
$34,500 $83,600 $4,750 plus 20% of the amount over $34,500
$83,600 $174,400 $17,025 plus 28% of the amount over $83,600
$174,400 $379,150 $42,449 plus 33% of the amount over $174,400
$379,150 no limit $110,016.50 plus 35% of the amount over $379,150
For a married couple filing jointly, the numbers are a little different:
If taxable income is over — But not over — The tax is —
$0 $17,000 10% of the amount
$17,000 $69,000 $1,700 plus 15% of the amount over $17,000
$69,000 $139,350 $9,500 plus 25% of the amount over $69,000
$139,350 $212,300 $27,087.50 plus 28% of the amount over $139,350
$212,300 $379,150 $47,513.50 plus 33% of the amount over $212,300
$379,150 no limit $102,574.00 plus 35% of the amount over $379,150
Its kind of confusing but let me outline a problem for you and maybe it’ll make sense. If Joe (a single guy) has an adjusted gross income of $10,000, he would be in what is called the 15% tax range, but he wouldn’t be taxed $1500 which is 15% of $10,000. Instead he would be taxed $850 on the first $8500. That leaves $1500 left to be taxed in the 15% range. 15% of 1500 is $225. So, Joe would be taxed $850 + $225, or $1075.
Here is another example. Melissa and Doug are filing a joint return. Together, their adjusted gross income is $150,000. That puts them in the 28% category. So, since they are married filing jointly, their first $17,000 is taxed at 10%, which is $1,700. The money that is between $17,000 and $69,000 is $52,000. (69,000-17,000) That amount is taxed 15%. 15% of $52,000 is $7,800. $7800 plus $1700 is $9,500. But, they still have some income that needs to be taxed in the 25 and 28% category. The amount in the 25% category is anything between 69,000 and 139,350. 139,350 – 69,000 is 70,350. 25% of 70,350 is 17,587.50. Add that to their 9,500 and you get $27,087.50 that they owe in taxes so far. One more step. Their adjusted gross income is $150,000. That is into the 28% range, but only by 10,650 (150,000 – 139,350). So $10,650 is the amount they will be taxed in the 28% range. 28% of 10,650 is $2982. Add that number to the taxes we already calculated ($27,087.50) and we end up with $30,069.50 that they owe in taxes. However, after figuring out this number, the next thing to do is to see which credits apply to Melissa and Doug. They may not end up paying that full amount.
I think thats about all for taxes today. I hope I didn’t confuse you too much. Its not too hard once you sit down and figure it all out. Don’t forget to track your spending in February! Good luck with the rest of that challenge.