Income Tax Basics

Looking to learn the income tax basics? First off, let’s get a few things straight. Yes, taxes kinda suck. Yes, the 16th Amendment, which ushered in the federal income tax in 1913, is a little shady. And yes, most people have no idea where their taxes actually go each year. Despite these things, everyone should know the basics about taxes because, like it or not, we gotta pay ‘em.  

The infamous income tax

As its name suggests, these are taxes you pay on the money you earn. This could include money you earn at your job, interest you earn from a savings or checking account (like anyone’s earning interest these days), retirement income, and a bunch of other sources of cash I won’t go into. In the U.S. we have what’s called a progressive tax system, which means that your tax rate goes up as you earn more money. There are ways to reduce your taxes, and I’ll get to those in a minute. Suffice it to say, if you’re getting paid, Uncle Sam wants a cut. And maybe that’s not such a bad thing. Like when your taxes are used to maintain our Interstate highways, run the National Park system, and pay our hard-working servicemen and women (albeit, not enough).

 

Paying your taxes

Uncle Sam’s gonna get his cut, one way or another. The simplest (and most common) way to pay your taxes is through your paycheck. Each time you get paid, your employer withholds federal and state taxes and forwards the money to the government. At tax time, when you get your W-2 (or 1099s if you’re self-employed, a contractor, etc.) and fill out your forms, you either get a refund or owe more. If you get a refund, it means you overpaid on your taxes throughout the year, effectively giving the IRS an interest-free loan with your hard-earned dollar. Not the best thing in the world I suppose, but at least you get a fat check that you weren’t expecting. On the other hand, if you owe money at tax time, it means you didn’t throw in enough cash and now it’s time to pay up.

 

Cutting your tax bill

As I said earlier, each of us pays a certain tax rate, based on how much money we earn. Whether you’re single or married also affects your tax rate. Despite your tax rate, there are lots of things that can cut your tax bill, such as deductions, exemptions, and credits. Deductions basically reduce the amount of tax you are responsible to pay. The Standard Deduction, for example, for a single (unmarried) taxpayer is $6,100. Similarly, the personal exemption is worth $3,900 to a single taxpayer. Credits also lower your taxes, and can even give you money back in the form of a refund. The Earned Income tax Credit (EITC) is a good one. If you make less than $51,567 you probably qualify.

 

Doing your taxes

You’ve got some options when it comes to actually doing your taxes.

 

Pen and paper

The old-skool way to do your taxes is with standard pen and paper. It takes a while and a little math, but you can’t beat the price (it’s free). Grab your tax forms online from the IRS, or get them at your local post office or library.

 

Computer, tablet, or phone

If pen and paper aren’t your thing, there are lots of mobile, online, and software options. I’d be lying if I said I wasn’t biased to Common Form. It’s easy to use, inexpensive, and there are no hidden fees. There’s something to be said for honesty these days, and Common Form gets it. Still, there are others options out there—some quite good.

 

Tax service

Your other option is to hire a tax service or professional tax preparer to do the heavy lifting for you. It’s certainly less effort on your part, but you have to pay for it. Costs range from an average of $218 for a standard 1040, to $806 for an 1120 Tax Form.  Of course, the peace of mind you get by not having to worry about your taxes might be incentive enough to pay top dollar to have someone else do them. That’s up to you.