Understanding Income Tax (It's Simpler Than You Think)

Each year, millions of Americans file an income tax return with the federal government. Many people also file income tax returns to their state and local governments as well. However, just because we are used to doing our taxes each year doesn’t necessarily mean that the tax code is easy to understand.

Understanding Personal and Business Taxes

Your tax liability is made up of both personal income taxes and FICA or business taxes. Personal income tax brackets start at 10 percent and go all the way to 39.6 percent. However, it is important to note that you don’t actually pay 10 percent of your income in taxes if you are in the 10 percent bracket or 39.6 percent of your income if you are in the top tax bracket.

Instead, your tax debt would be 10 percent on all income up to $9,225, 15 percent on income up to $37,450 plus $922.50 and progressively higher as your income increases.

In addition to your personal taxes, you owe Medicaid and social security insurance taxes that equal 15.3 percent of your income. However, employees only pay half of that amount while self-employed individuals get a deduction equal to half of their self-employment taxes.

Start Your Return by Adding Up All of Your Income

The first step in calculating your income tax is to tally up all the income that you have received throughout the year. As a general rule, if you have been paid by an employer, earned a profit from a sale or even made a net gambling profit, you have to claim it as income.

You may also have to claim alimony payments or payments or settlements from a personal injury case as income. However, most taxpayers will only have a W-2 from their employers or a Form 1099 if they are independent contractors who have made more than $600 from a particular client.

If you don’t know if a particular payment or any other source of revenue should be considered taxable income, ask an accountant or tax professional. However, it is always a good idea to keep a record of every dollar you made just in case you have to claim it or defend why you didn’t claim it.

Adjust Your Income for Credits and Deductions

After you have tallied up your earnings from the past year, you can now start to look for credits and deductions. Credits reduce your taxable income by the amount of the credit while deductions simply reduce the amount of money that is taxed. Let’s say that you owed $1,000 to the federal government and had a $500 credit.

In that scenario, you would now only owe $500 to the federal government. Let’s say that you are in the 10 percent bracket, which means that you had $10,000 worth of taxable income this year. A $1,000 deduction means you are now taxed on $9,000 of income, which means you now owe $900.

Taxpayers may take either a standard deduction or itemize their tax returns to deduct charitable contributions or to deduct mortgage interest. Most people will save more by taking the standard deduction that is automatically applied when you start an electronic return.

Taxes Are Generally Withheld Throughout the Year

If you are an employee of a company, you will have your income and FICA taxes withheld from each paycheck automatically. Therefore, when you file your return, you are simply verifying that you have paid the taxes that you owe and sending a record of payment to the government.

In most cases, you will be entitled to a federal refund when you file each April or October if you ask for an extension. If you are an independent contractor, you are responsible for sending in your own tax payments four times a year to cover your personal income and business taxes.

At any time during the year, you can use an income tax refund calculator to determine how much you can expect back from the government. As these calculators are only as accurate as the information that you provide, be sure to use timely information when you calculate your tax refund. Otherwise, your refund may be much lower than you anticipated, or it may turn out that you actually owe the government money.

Tax Negotiation

If your financial situation is dire and you’re indebted to the IRS, negotiating your taxes with them may be a viable option. Depending on your ability to pay back the requested amount, the IRS may offer the option to pay in multiple installments over a set amount of time. This is typically offered in cases where the indebted party cannot collect the expected funds and pay in one lump sum. In rare cases, the IRS may even opt to forgive your debt completely.

Despite what you may believe, the IRS has become increasingly willing to negotiate with taxpayers. By contacting the IRS directly and openly discussing your financial situation, a representative will be able to explore alternate payment methods and help find one that suits your needs. By recommendation, they may even accept monthly installments over the course of a few years.

It’s important to be completely honest about your finances with the agent working with you, as they can only help if they have all the information. If you’re unable to make a payment, the IRS has the legal authority to garnish your wages, reclaim your property, and even seize your bank accounts.

In cases where you feel uncomfortable negotiating with the IRS, it may be valuable to seek legal representation from a certified tax attorney. As we’ll discuss below, they can give you an edge when it comes to legal terminology, as well the inner workings of the tax system.

Tax Attorneys

Being able to read and comprehend legal talk and documentation is a rare skill unless you’ve had proper training. Likewise, navigating the legal system in the hopes of getting a fair tax settlement can seem impossible without help, and tax attorney does exactly that. Tax attorneys specialize in the sections of law that pertain to taxes and will be able to guide you through the confusing parts of a negotiation with the IRS.

If you find yourself incapable of paying your taxes, or unable to come to an agreement with an IRS representative, a tax attorney will be able to open doors you may not have been aware of. They can handle your documents, respond to audits and collection notices, and communicate with an IRS agent on your behalf. Additionally, they can help you dispute any existing steps the IRS has taken in securing your property and bank accounts.

Alternatively, a tax accountant could prove to be a useful tool in your negotiations with the IRS. Tax accountants don’t represent you legally but can sort out the actual filing and amending of your tax returns. It’s important to file your tax return, even if its late, and if you aren’t confident in your ability to file an accurate one, a tax accountant can do it for you. They will personally sort through all your tax documents and calculate deductions in the hopes of giving the IRS the most accurate representation of your financial standing.

Talk to an Accountant If You Have a Complex Return

While the tax code may be confusing, the good news is that you don’t have to file a return alone. If you run a business, have investment income or don’t want to make a mistake on your Form 1040, it is possible to have an accountant do your taxes for you.

Those who turn to a professional for help should work with a CPA or an enrolled agent as they have formal educations as it relates to the tax code. Enrolled agents have been certified to help taxpayers in the event that are audited, which means they understand that tax code well enough to help with even the most complicated returns.

Understanding income tax is a lot easier than you may imagine. All you have to do is figure out how much you made in the past year, account for deductions and credits and use tax brackets to determine how much of your income goes to the government. If you have any questions or concerns, there are plenty of resources available to help ensure that you file a timely and accurate return each year.

wavebreakmedia / Shutterstock.com

wavebreakmedia / Shutterstock.com



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