Congratulations, it’s your first paying job, and you’re excited to get your first paycheck. Your offer letter said you’d be paid enough to ball out this weekend, so you’ve been planning which swanky club you’re going to this Saturday. You get an email saying your paycheck has been deposited in your bank account, so you excitedly open up your account. Wait, what the hell. This isn’t the amount you’ve been promised. Who did this. What injustice has been brought down upon you today, and who do you have to smite to right it.
Welcome to income taxes! For the 70+% of people in this country who get their sole money through a salary, they’ll have to worry about this for the rest of their life. I guess now you see why people become Republican. Yay!
When you get a paycheck, a portion of that paycheck goes to the government. The federal government, state, and local government can take a portion of your paycheck away. This is called a withholding. More technically, your employer withholds this money to pay to the government.
You can control how much money that’s withhold through allowances, which you set on your W-4 form (that one form you filled out during onboarding. Yes, it’s important). If you have zero allowances, you are letting your employer withhold the max amount of money possible, which will eventually go to governments. If you max out your allowances, you will be paid an amount close to the salary originally stated on your offer letter.
Phrasing it like this, it seems like everyone should always max out their allowances. That is a terrible idea. Don’t do that.
When tax season arrives (late-January to mid-April), people file taxes. Filing taxes means calculating how much taxes you owe the government. If you’ve let a portion of your paycheck be withheld, that money has already been paid to governments. If the amount of taxes owed is less than the total amount of money you’ve been withholding on your paycheck, then that means you’ve overpaid. The government (combining federal,state, and local governments here for readability) has to give back the money you’ve overpaid. This is called a tax refund. On the other hand, if the amount of taxes you owe is more than the amount of money you’ve been withholding, you now owe the government money.
If you’ve been maxing out your allowances, that means you’re guaranteed to owe the government money. If you’ve been saving up specifically to pay taxes, then you’re fine, but if you haven’t, then you’ve screwed yourself. Don’t mess with the IRS.
Come tax season, you file a form called the 1040, before April 15th. This is basically the master form that tallies up everything relevant and decides if you owe the government, or the government owes you.
Your employer will give you a W-2 form. This is the master form for your income, and all the withholdings and allowances you’ve made. If the only taxes you have to worry about are income taxes, then this is the only tax form you really need to create your 1040 form.
These were the tax brackets for 2018 single people:
At first this may seem confusing, but it’s not impossible to understand. Say you earn 83,000 dollars per year. For the first 9525 dollars, you get taxed 10% (first row). After that, you move up a bracket, and the amount taxed from 9,526 to 38,700 is 12% (second row). You keep doing this until you reach the fourth row, where your taxed 24% for every dollar above 82,501. Working out in an equation, you get:
(9,525)*(.10) + (38,700-9,525)*(.12) + (82,500-38700)*(.22) + (83,000-82500)*(.24) =
(9,525)*(.10) + (29175)*(.12) + (43,800)*(.22) + (500)*(.24) =
952.5 + 3501 + 9636 + 120 = 14,209.5
So, you owe $14,209.5 taxes to the government. The important thing to note here is that the marginal tax rate system means that you will never lose money in taxes by making more money. For every additional dollar you make in income, you will get to keep a portion of that dollar. Tax plans and rates changing is a whole other story though.
Deductions are things that allow you to decrease your taxable income. Deductions are good for you, because they save you money. When a deduction decreases your taxable income, a portion of your income will not be taxed. This means you don’t have to give taxes on that portion of your income, and keep the money that you would have been taxed, for yourself.
When you deduct taxes, you can choose two methods. You can either use the standard deduction, or you can itemize your deductions. For every tax season, there exists a standard deduction with a set number. Anyone can choose to deduct the standard deduction amount from their taxable income.
On the other hand, there are individual deductions that exist. If someone has had life events in a year that qualify for deductions, these events can be used. If a taxpayer wants to tally up the total amount of deductions, and use these for their tax filings, this is called an itemized deduction. You can only file either a standard deduction, or itemized deductions, not both, so itemizing deductions is only worth it when itemizing deductions leads to a larger amount than the standard deduction.
There is, however, an exception to the rule. Above-the-line deductions are deductions that can added on to the standard deduction, without needing to be itemized. These deductions include traditional IRA contributions (explained in the next part), alimony payments, or certain education expenses.
In 2018, the standard deduction was $12,500. Let’s go back to assuming you make $83,000 per year. If a taxpayer uses the standardized deduction, there taxable income falls to 70,500, and they would owe:
(9,525)*(.10) + (38,700-9,525)*(.12) + (70,500-38,700)*(.22) =
(9,525)*(.10) + (29175)*(.12) + (31,800)*(.22)=
952.5 + 3501 + 6996 = 11,449.5.
A deduction of 12,500 saves the person making 83,000 a little less than 3000 dollars.
There also exists tax credits. Tax credits directly subtract tax liability. If a taxpayer owes 11.5k in taxes, and uses a 2k tax credit, the taxpayer now owes 9.5k instead. Tax credits are a lot simpler than tax deductions, and save more money. A 10k tax credit will cut more taxes than a 10k tax deduction.
Death And Taxes
That’s pretty much it. If you plan on earning money with just a job your whole life (not the best idea, but being employed is better than unemployed), then this is pretty much all you need to know. There are however, a bunch of ways to tax-advantage your life, and this will be discussed in the next section.