|
Fundamentals
of Income Taxes
Federal Income
Taxes - A simple concept with very complicated details.
Our federal income tax system was implemented in 1913 simply as a way
for the government to collect revenue. Since then, the laws have been
expanded and revised dozens, if not hundreds of times. If history is any
guide, you can expect the tax laws to continue to change and probably
get even more complex.
While you probably
do not want to spend the time and effort to become an income tax expert,
by understanding some of the basics you can make better financial decisions
and remove some of the anxiety surrounding this financial fact of life.
Everyone's tax situation can be different and this article covers only
some of the basics. If your situation is complicated or if you feel that
you need an expert to help with your taxes, do not hesitate to use the
services of a professional.
|
Fundamentals
|
|
The very,
very basics
- You add
up your income. Most types of income (wages, interest, dividends,
and capital gains) are included.
- Perhaps,
you then make certain adjustments. These adjustments are usually
for certain IRA contributions and business expenses.
- You then
subtract either a standard deduction (set by the government) or
the total of your itemized deductions (state and local taxes,
charitable contributions, mortgage interest).
- This leaves
you with your taxable income.
- You then
apply a series of tax rates to certain levels of taxable income.
Higher income gets taxed at higher rates.
- You then
compare your calculated tax with the taxes that have been withheld
from your paychecks (and additional estimated tax payments you
may have made).
- The difference
is what you owe when you file your return on April 15th or what
you will receive as a refund.
|
|
A
few more details
|
|
Income subject
to tax -
Most of the
income you receive by working or by investing is taxable. Along
with the items mentioned above, distributions from retirement plans
(unless rolled into an IRA), lottery winnings, rental income, alimony
and business income are taxable. However, interest from municipal
bonds is usually not taxable. Dividends and long term capital gains
(from investments held for more than a year) are taxed at a lower
rate than other income.
|
|
Adjustments
-
If you are
not eligible to participate in a company sponsored retirement plan
or if your adjusted gross income is below a certain level, contributions
to a regular IRA are deductible. The current limit on IRA contributions
is $5,500. You may also be eligible to make adjustments for certain
educational and business expenses.
|
|
Deductions
-
You are allowed
to reduce your income subject to tax for certain types of expenses,
including state and local income taxes, charitable contributions,
mortgage interest and medical expenses in some cases. If you do
not have these expenses or if your level of these expenses is low,
the law provides a standard deduction.
For 2018, the
standard deduction for individual is $12,000 and $24,000 for married
couples.
|
|
Tax rates
-
Our tax system
has progressive marginal tax rates. That means that income at lower
levels is taxed at lower rates and income at higher levels is taxed
at higher rates. There are also different rates for those that file
individual returns and those married couples filing joint returns.
|
|
|
Income
Tax Rate Schedules for 2018
|
|
2018
Single Return Rate Schedule
|
|
2018
Married Filing Jointly Rate Schedule
|
|
Taxable
income levels
|
Tax
rate
|
|
Taxable
income levels
|
Tax
rate
|
|
0
to $9,525
|
10%
|
|
0
to $19,050
|
10%
|
|
$9,526
to $38,700
|
12%
|
|
$19,051
to $77,400
|
12%
|
|
$38,701
to $82,500
|
22%
|
|
$77,401
to $165,000
|
22%
|
|
$82,501
to $157,500
|
24%
|
|
$165,001
to $315,000
|
24%
|
|
$157,501
to $200,000
|
32%
|
|
$315,001
to $400,000
|
32%
|
|
$200,201
to $500,000
|
35%
|
|
$400,001
to $600,000
|
35%
|
|
Over
$500,000
|
37%
|
|
Over
$600,000
|
37%
|
Long
term capital gains and qualifying dividends receive favorable tax
treatment, based on taxable income levels.
|
2018
Taxation of Dividends and Long Term
Capital Gains
|
|
Tax
rate on long term capital gains and qualifying dividends
|
Taxable
income levels for those filing individual returns
|
Taxable
income levels for those filing joint returns
|
|
0%
|
Under
$38,600
|
Under
$77,200
|
|
15%
|
$38,600
to $425,800
|
$77,200
to $479,000
|
|
20%
|
Over
$425,800
|
Over
$479,000
|
Depending
on your situation, there may also a few “credits” that can be applied
to reduce your taxes for things like foreign taxes and certain education
expenses. The net result
is your income tax liability for the year.
|
|
Filing your
returns -
You must
file your income tax return by April 15th each year. There are some
rules that enable you to get an extension of time, but most people
file by the due date. Getting an extension does not allow you to
delay paying any taxes you may owe. For most people, the taxes that
are withheld from their paychecks cover what they owe or come very
close. If you have a relatively large amount of investment or other
income, you may want to consider making estimated payments throughout
the year to avoid owing any penalties or interest.
|
Being tax sensitive,
not tax foolish
No one wants to pay any more tax than what they are legally required to
pay. The expenses of owning a home can provide itemized deductions and
contributions to your company retirement plan or IRA can also reduce your
taxes. But be sure to not let the idea of saving taxes cause you to make
financial mistakes.
|