5 Things Every Adult Needs to Know About Taxes
As an adult in the US, there are some things you definitely need to know about taxes. They can be confusing, yes, but if you know a few key items, you’ll be able to navigate the world of taxes and the IRS more confidently and effectively.
How the US tax system works
The US tax system is a progressive tax system. This means that if you have a higher income, you have higher taxes. If you have a lower income, you pay lower taxes. Plus, you don’t pay the same amount on every dollar. The tax bracket system means that you are taxed a certain percentage for each part of the bracket.
As an individual, you pay 10% on the first $9,525. Your earnings for $9,526-$38,700 are then taxed at 12%. So, just because you make $35,000 doesn’t mean that you pay 12% on this entire amount. Instead, you pay 10% of $9,523 + 12% of the remaining $25,475.
Taxes in the US are also on a pay as you go system. Instead of paying your entire tax bill at “tax time,” you actually pay it in little bits throughout the year. The withholding from your paycheck is your little bits being paid in over the course of the year. If you are self-employed, you use a different system – quarterly taxes – to do the same. Then, come tax time, you square up based on your actual situation. The pay as you go system allows the government to ensure they will definitely be paid.
You should file on time
You will be penalized if your file your return or pay your tax bill late. Penalties can be 4.5% of your tax bill per month for not filing, plus another 0.5% per month for not paying. These penalties (plus interest) can add up very quickly.
If you are unable to finish your taxes on time, you should consider filing an extension. An extension gives you more time to file your return (the paper form i.e. Form 1040) If you do go this route, be sure to file for an extension before Tax Day. Just note, an extension to file is not an extension to pay. Try to send at least part of what you expect to owe. This can help avoid some penalties.
Even if you can’t pay your tax bill immediately, filing your return anyway can save you from a large amount in penalties. As noted above, there are separate penalties for not filing and not paying. Filing but not playing allows you to avoid one fine, even if you have to pay the other. Plus, there are some options when it comes to paying your bill: the IRS accepts credit cards and you can also set up a payment plan. You do have options that you can explore.
The difference between deductions & credits
You may have heard the terms deductions and credits used when talking about taxes. Did you know they are two different things? Though both are great ways to save on your tax bill, the specifics regarding each option vary.
A deduction is a dollar amount that you can subtract from your taxable income. This is helpful because a lower taxable income equals a lower tax bill.
On the other hand, a credit is a dollar for dollar reduction of your tax bill. You can actually subtract the amount of the credit off of your bill. Some credits are refundable and some are not. With a refundable credit, if your tax bill is $400 and you receive a $500 credit, you will actually get at $100 refund! Refundable credits are very helpful. Unfortunately, most credits are not refundable.
A refund is not always a good thing
So, you got a refund at tax time! Great, right? Well, maybe.
A refund is not actually the free money that most people believe it to be. It is actually an overpayment of your taxes throughout the year. It is money that did not need to be paid to the government. So, essentially, you are giving an interest-free loan to the government.
The reason this is not ideal is that, instead of getting that money back in the form of a refund, you could have been using it throughout the year. Maybe, you could have had more room in your budget or paid down some of your debt. Or, you could have saved it in a place where it could have earned interest!
On the plus side, receiving a refund is not all bad. It can be mentally easier to know you would not have to pay at tax time. Plus, some people use it as self-imposed savings that they cannot touch. Just be sure your refund is not huge, as you lose more benefits this way.
How W-4’s work
W-4’s are the tax forms that you have to fill out when you start a job. It tells your employer how much tax to withhold from your paychecks. But, they can be a little confusing.
The main portion of the W-4 is where you write a number telling how many allowances you want to claim. Allowances are what tell your employer how much to withhold. The more allowances you claim, the less money is withheld from your paycheck. Conversely, the fewer allowances you claim, the more money is withheld from your paycheck.
The tricky part is that if you have too little withheld throughout the year, you might have to pay income tax time. If you have too much withheld, you’re more likely to receive a large refund and have less money to live on in the meantime.
Don’t forget, if you are married, your allowances and your partner’s affect your entire tax situation together. You can usually change your withholding at any time of the year; just ask your employer.
Filling out a W-4 is a balancing act. Luckily, there are some broad generalizations:
- If you are claimed as a dependent: claim zero.
- If you’re single and have one job: usually claim two.
- If you are married without kids: between you and your partner, you should claim two.
- If you are married with kids: between you and your partner, claim two plus, one for each child.
- If you are unsure what to claim or have a more complicated situation, check out the IRS withholding calculator. This can help you choose the best way to fill in your W-4.
When to get help
Even with a thorough knowledge of US taxes, they can be confusing. In these cases, it may be a good idea to get some help. There are a number of factors that make help more pertinent, including:
- Being self-employed
- Having a big life change – having a baby, getting married, buying a house
- Cashing in investments frequently
- Taking complex deductions and credits
Getting help from a tax professional can go a long way in ensuring your tax life is sound. Look for one that will be able to offer sound advice for your unique situation.
Have more questions about US taxes? Let us know how we can help!
