What You Need To Know About Taxes
What You Need To Know About Taxes
Do you need a lot of people who are excited about filing their tax returns? I know I don’t. And let’s be honest here: there’s really not much to rejoice over. There are mainly two reasons why people have such a relationship with the concept of “doing their taxes”
- Paying your taxes every year can turn out to be very expensive. When you look at your paycheck after withholding for federal income taxes, you may feel like you’ve literally been robbed. And we’re not even going to get into state income taxes, as well as Social Security and Medicare taxes.
- Second, the tax law is very complicated and changing all the time. It’s amazing how much tax law has grown over the past 100 years or so. We went from 400 pages in 1913 to more than 80,000 in 2009. And this is not something that’s going to change any time soon, because Congress brings changes to tax law to a greater or lesser extent every single year. In addition, new court decisions and IRS rulings appear each day, providing guidance on how to interpret the law.
How can you feel anything but dread when it comes to taxes? One of the things that can make it less of a financial burden is the fact that tax law is peppered with many, many tax breaks for which you may qualify. In the end, if you take advantage of everything that you qualify for, you may end up with a tax bill that’s far less than what you thought you would have had to pay in the first place. These breaks allow you to not report certain economic benefits you enjoy or subtract certain expenses from your income or even directly from your tax bill. So get your tax affairs in order, find out what breaks you can take advantage of, and reduce what you pay each year to Uncle Sam. After all, paying more than you should is not a good thing for you.
In getting a handle on how to do this by taking advantage of every tax break you may be entitled to without getting in trouble with the Internal Revenue Service (IRS), there are a few simple things you need to know. They include (but are not limited to):
- You are legally obligated to report all of your income unless a specific law allows you to exclude or exempt it (so that it is never taxed) or defer it (so that it is taxed at a later time). But while it’s true that all income is presumed to be taxable, it’s also true that different types of income are taxed in different ways: for example wages are subject to several different types of tax rates while dividends and capital gains may be taxed at a lower rate.
- You can claim certain deductions only when and to the extent the law allows. Deductions are referred to as a “matter of legislative grace”; Congress doesn’t have to create them and does so only for some purpose (for example, to encourage economic activity or to balance some perceived inequity in the tax law).
- Tax credits are worth more than tax deductions. A credit reduces your tax payment on a dollar-for-dollar basis; a $1,000 credit saves you $1,000 in taxes. A deduction is worth only as much as the top tax bracket you are in. Suppose you are in the 28 percent tax bracket, which means this is the highest rate you pay on at least some of your income. If you have a $1,000 deduction, it is worth $280 (28 percent of $1,000) because it saves you $280 in taxes you would otherwise have to pay.
- Even if your income is modest, you may have to file Form 1040 (the so-called “long form”), rather than a simplified return (Form 1040A or 1040EZ), in order to claim certain tax benefits.
- In a number of cases, different deduction rules apply to the alternative minimum tax (AMT), a shadow tax system that ensures you pay at least some tax if your regular income tax is lower than it would have been without certain deductions.
Remember that we mentioned that tax law is constantly changing? Well that’s also something that you should definitely keep in mind, because it can affect you. For example, Congress in 2001 made changes to college 529 savings plans. This change allowed people to make “qualifying withdrawals” that no tax would have to be paid on (those qualifying expenses were stuff like college tuition, room & board, books). Those changes weren’t permanent though; they’re expiring in 2011. So when that year comes, if you’ve been impacted in one way or another by this change, you have to be aware of what’s happening with it so you can prepare yourself adequately.
Whether you prepare your return by hand, use computer software or an online tax preparation software solution, or rely on a tax preparation service, it’s always good for you to know every tax edge you’re entitled to. Knowing what to look out for will help you plan ahead and organize your activities in such a way that you’ll share less of your hard-earned money with Uncle Sam.