Note: Here on MHM, February is our dedicated "Tax Month" with new posts coming weekly, so subscribe (by reader or e-mail) and stay tuned!
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?