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.
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.