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Own Banker
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For almost 100 years, Americans have been paying
federal income taxes. In return, the government
has defended our freedom, built highways,
preserved natural resources and funded programs
that have helped all Americans. Over those same
years, the income tax law itself and the rules
surrounding the law have become huge, complex
and confusing. Many have found that professional
income tax advisors, and software programs are
essential for preparing tax returns and just
dealing with all the financial issues associated
with income taxes.
This article does not replace the expert
advice of professionals, but rather explains
some of the basics so you can better understand
how our income tax structure works, how it can
affect your financial decisions and how you can
be a more-informed income taxpayer.
Our income tax system is generally described
as a progressive, marginal rate system. This
means that as we earn more income, we pay higher
rates of tax on that income. To better
understand this, consider the following three
components – how much is taxed, what tax rates
apply and how do we pay the tax. Then,
unfortunately, there are all the additional
rules.
How much is taxed – or what is taxable
income?
When you prepare your tax return (Form 1040), or
gather information for your return accountant,
you probably start by identifying all your
income for the year. This includes your wages
(reported on Form W-2 and supplied by your
employer), dividends and interest (reported on
Form 1099 and supplied by your bank, credit
union, brokerage firm and others), any capital
gains you had during the year (determined by your
own records or supplied by a mutual fund or
brokerage firm) and income from self employment,
retirement plan distributions, Social Security
income and other sources. You then get
reductions for deductible IRA or retirement plan
contributions and other items.
The next step is to determine your
deductions. The tax law allows itemized
deductions for state and local taxes, interest
paid on mortgages, charitable contributions,
medical expenses that exceed certain levels and
a few other items. If you do not have large
amounts of itemized deductions, you can take a
"standard deduction." After all the needed
calculations, you arrive at your "taxable
income."
Paying your income taxes
Your employer withholds federal income taxes
from your paychecks and forwards those funds to
the government. This is reflected in your Form
W-2 along with your earnings and Social Security
withholding. The amount of income tax they
withhold is based on the Form W-4 on which you
identify the number of "exemptions" you claim.
The larger the number of exemptions, the less
they withhold.
Some individuals also end up making quarterly
estimated income tax payments if they suspect
their withholding will not be sufficient. There
can be interest and penalties if the total of
your withholding and estimated payments are too
little.
You then compare your income tax liability
with the total payments you have already made
and the difference is what you owe or the amount
of refund you should receive.
Other issues
This article has only provided some of the very
basics of our income tax laws. The Alternative
Minimum Tax, special distributions from
retirement plans, stock options, and changes in
marital status are just a few of the hundreds,
if not thousands, of other issues that can
complicate your situation.
Each person’s situation is different, the
rules are complex and the consequences of not
following the rules can be severe. Be sure you
get the tax advice you want and need from a
qualified professional.
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