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Taxes.
Taxes.
Honestly, this was a tough article to write. Not because I
don’t like taxes (hey, I have a master’s degree in taxation—I better like taxes)—but
because the topic is so ridiculously unwieldy. And let me quickly tell you why
it’s unwieldy. Taxation is a patchwork. It’s people finding loopholes and the
government creating rules to close those loopholes. It’s trying to apply one
system to hundreds of millions of people with unique situations and
circumstances. It’s also politics. In short, it’s messy.
But set all that aside, and we want you to know that, in
general, the ideas that the average person needs to know are very
basic. And that basic understanding of what’s going on will help you feel in
control when April 15th rolls around. Feeling empowered already?
Good. Let’s get started.
What kinds of taxes
are there? The government taxes you on a lot of things. Here are just a few
of the most common ones:
- Your purchases of goods (sales tax),
- The value of your real estate (property tax),
- The value of your inheritance (estate tax),
- The amount you earn from your employer (FICA), and
- The amount you make as a self-employed person (Self-employment Tax).
But we’re not talking about those here. We’re talking about
the Income Tax, which is (not surprisingly) a tax on your income for the year. You
know, the one you calculate on that form that’s due April 15 every year.
Here are the basics we want you to know:
Your tax return
refers to income earned in the prior year. This year (2013) you filed your
2012 tax return on income earned from January 1, 2012 to December 31, 2012.
After the last day of the year, the government gives you until April 15, 2013
to get your junk together and figure out your taxes for 2012. Sometimes people
with complicated returns need even more time to figure out how much they owe.
They (and anyone, really) can file for an automatic-six month extension. Don’t
get too excited, though, this isn’t an extension of time to pay, just time to
file. Speaking of which…
When do you pay your
taxes? Technically, the money isn’t really due in one lump sum on April 15th.
It’s due throughout the year in four quarterly installments. Most people don’t
even think about this because it’s automatically done for you by your employer
before the money even hits your bank account. But if you’re self-employed or
have income from other sources, you may have to make these “estimated payments.”
They’re estimated because you don’t actually
know how much you’ll really owe until you file your tax return and come up
with the final amount. So when you file your return in April, you’ll realize
that either you overpaid, and get a refund, or you underpaid and have an
additional amount due (along with possibly some penalties and interest). Why
does the government do this? The earlier they get the money, the more time they
get to earn interest on it. That’s why, for the tax hip mama, the goal isn’t to
get a huge refund, the goal is to come close to $0 refund/due. After all, who
wants to give the government an interest-free loan?
What’s the deal with FICA?
Isn’t that the same thing as income tax? Not exactly. FICA (Federal Insurance
Contributions Act tax) is specifically for funding Social Security and
Medicare. This tax is split halvsies between you and your employer. Your portion
comes out of your paycheck, just like your income tax. If you’re self-employed,
you have to pay both halves yourself.
What’s the difference
between a deduction and a credit? There’s a big difference! A deduction
reduces your taxable income, so your savings won’t be the amount of the
deduction, it will be the amount of the deduction times the tax rate. For
example, say you donate $100 to charity. You don’t save $100. How much you save
depends on your tax bracket. If you’re in the 25-percent tax bracket, for
example, you save $25 ($100 x 25% tax rate).
Why are people always
talking about deducting their mortgage interest? How does that work? Okay,
things are about to get a little nitty gritty, so be prepared. Remember how we
just talked about what a deduction is? At a certain point in calculating your
tax, the government gives you two options. Option A: The standard deduction ($6,100
for a single filer in 2013, or twice that if you’re filing a joint return). Or
Option B: Itemized deductions. Itemized deductions include things like mortgage
interest, charitable contributions, and state income taxes, to name a few. If
you add all those up and the total is more than the standard deduction, then
that total is what you’re going to subtract instead. Typically, people don’t
have enough itemized deductions to exceed their standard deduction unless they
have a mortgage (although, that alone is clearly not enough reason to buy a
home.) My husband and I like to “bunch” our itemized deductions to save a lot
of money on our taxes!
Okay. So take a deep breath. You now know way more about
taxes than the average person. Ready to
go farther down the rabbit hole? Click the links below.
- How do I make estimated tax payments?
- How the heck is my tax calculated?
- What are some easy ways to file my return?
- What’s the deal with tax brackets?
- Can you tell me more about FICA andself-employment tax? I’m really intrigued…
- You mentioned bunching of itemized deductions—I want in! Tell me how!
- How do I deduct charitable contributions?
- Can you explain the different forms to me?
First of all I love your blog...it has motivated me to get on top of my finances and budgeting.
ReplyDeleteSo I have a tax question. Do I need to save receipts for tax-related things like healthcare costs. Or is keeping my monthly credit card statement with health care expenses on it enough.
So glad our blog has been helpful! To be safe, I would probably keep both receipts and the credit card statement if the receipt has more helpful detail on it. This IRS publication is pretty helpful, ctrl + f for "proof of payment," "medical and dental expenses," and "how long to keep records." (http://www.irs.gov/publications/p552/ar02.html) Hope that helps!
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