Tax 101
- Tax Topics [1]
- Jul 29, 2024
- 3 min read
Updated: Aug 2, 2024
Taxes are an important part of your financial life. Understanding how federal income taxes work and filing your taxes correctly can help you keep more of your hard-earned money. In this brief introduction, we'll explore the basics of US individual taxes.
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Why do we pay taxes?
Taxes are the government’s main source of revenue. They fund various public services, such as schools, roads, healthcare, defense, and social programs; in other words, taxes play a crucial role in supporting government activities and services that benefit everyone in the United States. When we each contribute our share, we help ensure the smooth functioning of society.
Common types of taxes
There are many different types of taxes. The most common ones for individuals are:
Federal Income Taxes: This is the tax you pay on income that you earned or obtained during the year. Your income can come from wages, business activities, interest, dividends, as well as other sources.
Payroll Taxes: Payroll taxes are taken from your paycheck to fund programs like Social Security, which provides retirement benefits, and Medicare, which offers healthcare services for seniors.
State and Local Taxes: State and local taxes are extra taxes collected by individual states or municipalities to fund infrastructure proiects and local government services.
Sales Taxes: A tax added to the price of goods and services when you make a purchase.
Property Taxes: If you own real estate, you may need to pay property taxes to your local government.
Key tax terms
Tax law is rooted in a large set of legal and financial terms. Fully understanding individual taxes will require you to understand the vocabulary as well.
Gross Income: This is the total income that you earned during the year. It includes wages, business activities, interest, dividends, and all other sorts of income.
Tax Deductions: These are expenses that you can subtract from your total income, reducing the amount of income that is subject to tax.
Taxable Income: This is the portion of your income that is subject to tax after deducting eligible expenses.
Tax Rate: Your tax rate is the rate or percentage at which your income is taxed; it therefore determines how much tax you will owe. A higher tax rate means you will pay more tax. For individuals, tax rates are graduated or progressive, meaning that higher tax rates are imposed on higher portions of income. Note that capital gains are generally taxed at a lower rate than other ordinary income. To learn more about capital gains and losses, see here.
Filing Status: Your filing status is relevant to your income taxes and determines the applicable tax rate. The five filing statuses are: Single, Married filing jointly, Married filing separately, Head of household, and Qualifying widow(er) with a dependent child.
Tax Credits: Credits directly reduce the amount of tax owed.
Tax Liability: The amount of taxes you owe after all deductions and credits have been taken into account.
The tax filing process
Gather Documents: Collect important documents like W-2s (from your employer) and 1099s (reporting various types of other income).
Choose a Filing Method: Taxes can be filed electronically, through an advisor, or on paper.
Calculate Tax: You can use tax forms or tax software to calculate your income, deductions, and credits to determine your tax liability.
Pay or Get a Refund: If you owe taxes, you will need to make a payment. However, if you have paid more than your total tax liability, you will receive a refund.
Deadline/Extensions: For most taxpayers, April 15 is the deadline for filing your federal tax return. But if you can't meet the deadline, you can file for an extension, giving you more time to complete your return.
Conclusion
Understanding individual taxes is a fundamental aspect of responsible financial management. By learning about the different types of taxes, filing statuses, and basic terms, you can better navigate the tax system. Remember that taxes can be complex, so seeking advice from a tax professional is always a wise choice. This introduction only skims the surface of the vast and complicated world of taxes. Browse through the site to learn more.